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Connect the Dots… to Lower Mortgage Rates

Current events give a good demonstration of what really drives market interest rates:

The reason for the drop in mortgage rates can be traced to a third significant development:

All of which suggests that potential homebuyers — or mortgage refinancers — would do well to keep their eyes on the price of oil in the weeks ahead. 

The power of the Fed

The decision of the Fed to keep rates unchanged is understandable, given that they are caught between the Scylla and Charybdis of recession and inflation. Even absent the threat of inflation, it’s questionable whether any further lowering of rates would have much stimulative effect. At 2%, the Fed’s short-term rate can’t get much lower, and to some extent the Fed’s actions in lowering rates has been what economists call ”pushing on a string” — they’ve made credit cheaper at a time when market demand for it is limited for other reasons, so its stimulative impact is muted.

That’s not to say the Fed is completely powerless. Its aggressiveness in lowering rates over the past year makes the most sense if it has been an unstated effort to bail out the floundering banking system. By helping banks borrow at super-low rates while they continue to lend at significantly higher rates, the Fed’s intention all along may have been to help restore some of the losses banks took on subprime loans, to keep them up and running as a source of credit in the future. 

What mortgage rates are responding to

Despite no change on the Fed’s part, it isn’t a shock that mortgage rates have been easing recently after a sustained rise in recent months. Mortgage rates have been going their own way all along. They certainly did not fall in lockstep with the Fed’s sustained drop in rates, because the mortgage market has been more concerned about inflation. This brings us to the chief driver of inflation in the current environment, and that is oil.

Oil hits a slick patch

With oil down around $120 a barrel after having traded above $147 just last month, some of the inflation concerns that had driven interest rates higher may begin to ease. While oil speculators are trying to position the pull-back as just a temporary correction in oil’s long-term rally, some indicators suggest that short-term speculation had gotten out ahead of the long-term trend of oil price increases, making this decline inevitable.

A continued drop in the price of oil would benefit consumers in several ways — immediately, by easing inflation at the gas pump and in general, and long-term, by easing interest rates. This, in turn, would stimulate the economy in a way that the Federal Reserve and government just are not in a position to do. Of course, this is far from a sure thing – continued declines in the price of oil depend on relative stability in the weather and in the Middle East, two of the more unstable factors on the planet. 

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