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Fannie Mae’s Home Purchase Sentiment Index offers a broad measure of housing market strength, and it was updated for the month of December this week to show an 8.2 percent improvement over December 2018.
There are several factors feeding into that number–all based on questions Fannie is asking consumers each month. The biggest shift in this month’s survey was among those who expect home prices to rise over the next 12 months with the percentage moving up a whopping 6 points from 44 to 50.
Consumers aren’t home price experts, of course, but a consumer who expects prices to rise is logically more willing to pay higher prices. This is one reason economists are always interested in consumer inflation expectations.
Other parts of the survey complement the conclusion about higher prices. Job security is arguably an important precursor to making mortgage payments and according to Fannie Mae, it improved by 2 percent. Additionally, more than 25% of respondents continued to characterize their income as “significantly higher” than it was a year ago.
And then there’s mortgage rates! First thing’s first: the average consumer is significantly more pessimistic on rates than reality suggests they should be. For instance, even as rates began to decline in 2019, more than 50% of respondents expected rates to rise and less than 10% expected them to fall. Fast forward to the present day and 2019 ended up being one of the best years for mortgage rates we’ve ever seen.
All that to say that we’re far more interested in how the existing percentages change as opposed to their outright levels. With that in mind, consumers have increasingly been expecting rates to rise again ever since the sharp surge lower in August 2019.
That’s actually a good thing for the housing market because the sentiment is not filtering through to other metrics that would speak to a discouraged homebuyer. Additionally, if rates manage to defy those expectations (again), it should only reinforce the generally optimistic attitudes that are already in place when it comes to home prices and buying/selling demand.
So what is going to happen with rates anyway?!
As always, financial markets have already accounted for the entirety of what can be known about the present and future direction of rates. Any insight available for our discussion is also already available to fuel the trading strategies of the people responsible for interest rate movement.
In other words, rates could go up, down or sideways! And the factors influencing those moves can change on a dime–a fact that was firmly reinforced over the past two weeks of geopolitical tensions between the US and Iran.
Specifically, Tuesday night was intense. Bonds surged to the best levels (i.e. lowest rates) in more than a month, and were close to the best levels in nearly 3 months after Iran attacked several air bases in Iraq. According to Twitter and more than a few news anchors “that meant war!” Had that sentiment been accurate, rates would have fallen precipitously.
Why is that?
Mortgage rates are tied to mortgage-backed-securities which are highly dependent on the movement of US Treasuries for general directional cues. Treasuries are an exceptionally liquid and virtually risk-free place for investors to park money during times of heightened uncertainty or economic pessimism. Geopolitical flare ups cause demand for Treasuries to spike, sending prices higher and yields lower. It’s that yield component of Treasuries that correlates with mortgage rates.
As it stands, there was no war, although Treasuries began to move in that direction before they had all the facts. As it became more and more likely that war would be avoided, Treasury yields moved back up toward previous levels, ultimately starting the day very close to where they left off on Tuesday afternoon.
But if rates fall in response to these sorts of risks, and if we came close to starting a war with Iran, how could that not be worth at least some small shred of improvement?!
Valid question, but an easy answer: rates had actually already reacted to the US/Iran flare-up at the end of last week after a US drone strike killed a top Iranian general. Markets had been waiting to see what the repercussion would be.
The Iranian attacks on Tuesday provided an answer. Yes, those attacks temporarily helped the bond market by increasing the risk of war, but by the time it became clear war was off the table, rates didn’t have any reason to be pricing-in the uncertainty of the Iranian response any longer. The following chart shows this timeline, including the Trump speech that confirmed “no war” on Wednesday morning.
Zooming out from all the near-term volatility, we find that rates continue to operate in a narrower and narrower range. The “consolidation pattern” seen in the next chart has been intact for months. When these sorts of patterns finally end, it’s common to see stronger momentum in one direction or the other.
At the moment, with top tier 30yr fixed offerings hanging out under 4%, it’s hard to be too concerned about where we are today. But fretting over the future is always fair game. With that in mind, let’s repeat a chart from the previous newsletter that showed the long-term trend in rates (as represented by 10yr Treasury yields–the benchmark for all longer-term rates in the US).
In other words, rates had a stellar run from long-term highs, ultimately bouncing near all-time lows. The last two times this has happened, it marked a big picture turning point that ultimately restored long-term highs.
A repeat performance is always possible, but there are a few things worth noting. First off, the other two examples both relied on a catalyst event for the majority of the momentum back toward higher rates. In 2013 it was the Fed signaling an end to QE (the bond-buying program that had helped rates realize all-time lows only a few months prior). In 2016 it was the market’s reaction to the presidential election.
So far, we don’t have an equivalent sort of motivation, just the initial corrective bounce that seems to be common for all 3 examples. To be fair, that motivation could materialize simply due to strong economic data and a solidified US/China trade deal, but neither is a given at this point. Conversely, there’s no rule that says rates can’t turn right back around and head lower again.
That sort of friendly momentum can come from things like geopolitical risks and disappointing economic data. It can even be as simple as traders seeing a show of support at any given ceiling level for rates. 1.95% in 10yr Treasury yields filled that role at the end of December (as seen in the chart below). By the end of this week, that supportive undertone was joined by geopolitical risk (escalation in US/Iran relations after a drone strike killed Iran’s top military leader) and weak manufacturing data on Friday morning.
If December looked like a dicey month for rates, remember, everything’s relative when it comes to mortgage rates. While it’s true that Treasury yields set the tone for overall rate momentum, mortgage rates are ultimately based on mortgage-specific bonds that can move a bit differently at times. December was one of those times–something we can easily see if we chart the movement in mortgage-backed securities versus Treasury yields.
The takeaway there is that mortgage rates were already near their lowest levels in a month a few days before Treasury yields experienced their biggest recent drop.
Why was the mortgage sector able to outperform Treasuries? There are several fairly boring, confusing reasons for that, but one fairly simple one. So let’s stick with what we know (i.e. everything’s relative for mortgage rates, and this is no exception). Simply put, mortgages were able to outperform Treasuries because they had underperformed so badly in August and September.
Explaining past movement is one thing. Getting ahead of the next big move is another. To reiterate, there’s certainly a concern about history repeating itself as seen in the first chart, but again, it will take a catalyst. Progressively stronger econ data in 2020 would do plenty of damage to rates, but there’s no way to know if that’s what we’ll see until we see it.
When it comes to deciding on what to watch, next week is a great candidate. It has a slew of the most important monthly economic reports, and it occurs on the first full week back from holiday breaks for many market participants. There’s also a high probability of additional headlines over the weekend that speak to geopolitical risks.
With new tariffs set to take effect on Sunday, Dec 15th, we knew big news became more and more likely as the week progressed. It arrived unequivocally on Thursday and remained front and center through Friday morning.
On average, traders expected some sort of cancellation or delay of the planned tariffs. Under the best circumstances, such a cancellation would come courtesy of the signing of what has become known as “phase 1” of a multifaceted trade deal. Phase 1 would provide a proof of concept to markets that the US and China could make progress on trade–thus making the broader deal more likely.
Thursday morning’s first piece of evidence–a Trump tweet that said “Getting VERY close to a BIG DEAL with China”–wasn’t destined to have a massive impact on markets. It was too vague to send too many shockwaves, but it did get things moving in that direction. Markets were also willing to take that more seriously than some other tweets due to the timing (i.e. traders were on edge waiting for trade-related updates before the weekend).
Less than an hour later, there was an even more meaningful headline quoting a Wall Street Journal (WSJ) story. The underlying article laid out specific changes in tariffs that had apparently been disclosed by sources from inside the administration. The relative impact is clear. The following chart shows the effect on rates/bonds (blue line) from each piece of news.
It’s worth taking a moment to remind ourselves that news suggesting improvement in US/China trade relations is generally good for stocks and bad for rates/bonds. The cause and effect exist on a spectrum where a grand, finalized, all-encompassing deal would put massive amounts of upward pressure on stocks and rates while minor updates simply account for smaller-scale volatility.
Thursday ended without any final confirmation that the phase 1 deal was in the books on an official level. The White House acknowledged its agreement, but details were lacking–especially the detail about China’s end of the agreement. That began to change on Friday.
The first two updates on Friday were actually good for rates and bad for stocks as they pushed back on the notion of a finalized deal. First up was a report that Chinese officials expressed concerns about US demands. After that, a Trump Tweet called the WSJ article into question–or so it seemed.
Trump’s tweet was actually in reference to a new article from Friday morning with the headline: “China Offers No Confirmation on U.S. Trade Deal” (the article was subsequently heavily edited and retitled to align with the reality we’re about to discuss).
Between those two pieces of news, markets were quickly heading back in the other direction. And while they would ultimately end up sticking with that decision, there was one more curveball that completely reversed the momentum. Actually it was less of a curveball and more of a logical development in the negotiation process. In short, Chinese officials held a news conference to confirm their agreement with the principles of the phase 1 deal.
Sounds simple, but it was a big, logical step in finalizing the phase 1 process. And remember that the more finalized the trade deal looks, the better it is for stocks and the worse it is for bonds. Both sides of the market reacted accordingly as the news conference got underway.
So why did they ultimately end up moving LOWER? It comes down to the fact that the deal, as it sits, is very light on details. For instance, China hasn’t yet put a number on agricultural purchases (a key consideration for the US). They’ve merely pledged it would be part of the deal once signed.
I say “once signed” because the deal isn’t signed yet and isn’t expected to be signed in 2019. This is another reason for some push back in financial markets. In a nutshell, traders quickly prepared for more sweeping accomplishments when the Chinese news conference began but soon pushed stock prices and interest rates back down as they learned how much work was left to be done AND that several important details had yet to be hammered out. Here’s how all of the above played out in the bigger picture:
The more we zoom out and reset the scale of the chart, the more the story shifts from massive back-and-forth swings to something much less volatile. True, volatility certainly exists over smaller time frames, but in the bigger picture, that volatility is playing out in a fairly narrow, sideways range for rates (blue lines in the following chart). That feels like a victory given the stock market’s ability to continue pushing into new all-time highs.
Making that victory slightly sweeter (or more bitter, depending on how you look at it) is the fact that the charts above rely on 10yr Treasury yields to convey general movement in the longer-term rate market. Mortgage rates tend to move almost exactly the same way, but often with less volatility in the bigger picture. For example, mortgages weren’t able to follow Treasuries lower as quickly in August, but the trade off is that they’ve experienced less volatility since then.