Wild Week for Mortgage News
It was a wild week for mortgage news:
- The Federal Reserve cut interest rates by another half percentage point
- Advance estimates of Gross Domestic Product indicate that 2007 was the slowest year for U.S. economic growth since 2002, when the country was coming out of a recession
- In another indication of economic weakness, mortgage foreclosures were reported to have soared in 2007
In the through-the-looking-glass world of interest rates, where bad economic news is often welcomed as a harbinger of lower rates, the consensus seemed to be rates would continue to fall. However, mortgage shoppers would be wise not to hold out for too long, because the story may not be as simple as all that.
Oops, He Did It Again
Federal Reserve Chairman Ben Bernanke is certainly proving to be a departure from his predecessors. He is clearly not the inscrutable incrementalist that Alan Greenspan was: Bernanke seems to signal his intentions in advance, and then make dramatic moves so as not to disappoint the financial markets. Nor is Bernanke the sworn inflation hawk that Paul Volcker was: the current Federal Reserve Board (and in truth, it is a board, not a single person acting unilaterally) seems committed to reviving growth at all costs.
The upshot of this was an extraordinary cut of the Fed discount rate by 1.25% in a week-and-a-half. On the surface, one might assume this was good news for lower interest rates across the board, but then, that wouldn’t explain the actions of the bond market.
Bonds Go Their Own Way
Treasury bond yields actually increased on the news of the latest cut in Fed rates. This is a good reminder that the power of the Federal Reserve to control market interest rates is limited, and in particular, short rates and long rates may have separate agendas.
In terms of why long rates ticked upward, it’s difficult to speak for a market, but a good guess is that it had something to do with inflation. Inflation is the sworn enemy of the bond market. To put it in more direct terms, higher inflation means higher interest rates. And the bond market may have reason to be concerned about inflation.
The Villain of the Piece
As is often the case, inflation is the villain of this piece. Inflation is a robber, eroding the value of assets and income. U.S. inflation just logged its largest calendar year increase since 1990. A looser monetary policy on the part of the Fed (e.g., aggressively cutting interest rates) tends to encourage inflation.
If inflation is a villain, one of its chief henchmen is oil. After subsiding for a few weeks, oil prices have ticked up since the January 22nd Fed rate cut. This is an ominous sign that we may not have seen the last of 2007’s inflation. This could well explain why bond market rates drifted higher rather than lower when the Fed cut rates again.
The Message
The bottom line is that home buyers and refinancers might not want to hold out for lower rates. Mortgage rates are already toward the lower end of their historical range, and as this week demonstrated, it is entirely possible for mortgage rates to head higher while Fed rates are lowered.
