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Are you mad? Whether you’re a housing/mortgage professional or simply a person who might like to buy/sell/refinance a house at some point in the near future, you have a right to be frustrated.
Housing is definitely in the midst of a cooling phase. There are many reasons for this, and they’re not all bad or abnormal. It’s hard to say which factors deserve the most blame, but everyone can agree that mortgage rates aren’t helping. After all, they’re as high as they’ve been since early 2011.
But before we get mad at interest rates, we need to remember they’re just responding to market forces and fiscal policies. We may want to blame rates, but rates want to place some blame as well. So who’s going to get it?
When it comes to blaming high rates on other factors, there are long-term and short-term considerations. This week, the most noticeable short-term factors were mid-term elections and the Federal Reserve’s policy statement.
With respect to elections, interest rates wanted Democrats to win a majority of the House. If the GOP had maintained control, it would have preserved the government’s ability to spend money more easily (something that hurt rates a lot in 2018). For the few moments where pollsters predicted a GOP advantage, rates spiked before finally moving back down when Democrats re-took the lead.
Later in the week, the Fed released its policy statement. No one expected the Fed to hike its policy rate this week, but investors often look for clues in Fed’s verbiage. This week’s Fed statement was almost identical to the last one. Financial markets were perhaps hoping the Fed would express some concern about October’s market volatility. Such a move could have helped interest rates because it would have implied some moderation to the Fed’s expected path of rate hikes in the future.
The following chart shows how rates reacted both to the election and the Fed. As you can see, by the end of the week, both events were lost in the shuffle.
One of the reasons rates may have been able to hold their ground is the stock market’s inability to break its mid-October ceiling. Rates and stocks definitely aren’t required to move in lock step, but rates have certainly been willing to take cues from stock market volatility in the past 30 days. This is just something to keep an eye on in the event stocks continue lower next week.
In the bigger picture, this week’s interest rate reaction isn’t even a blip on the radar. Rates would need to see A LOT more stock drama in order to reverse the upward trend that’s been in place since mid-2016.
If we really want to figure out where to place the blame for higher rates, we’ll need to look well beyond the Fed. We’ve done this in the past by talking about fiscal policies like the tax bill or economic risks surrounding growth and inflation. We’ll be revisiting those bigger picture themes in the future, but let’s stick with the Fed for now. Even though their policies are mostly a response to financial conditions, it’s nonetheless fashionable to blame them for creating those financial conditions.
Is any of that deserved? As a matter of fact, SOME of it IS deserved when it comes to mortgage rates. Don’t get me wrong. We wouldn’t even have the mortgage market as we know it today without the Fed’s intervention. On the friend/foe scale, they’ve been our biggest friend. But the time has come for them to be a bit less friendly, and that’s been hurting mortgage rates more than it’s been hurting rates in general.
It’s hard to explain why this is the case without going into mind-numbing detail, but here’s the simple version. The Fed had been buying a lot of mortgage-backed debt (along with US Treasuries) in the past as a part of crisis response beginning in 2009. Buying debt helped push rates lower.
Even when they weren’t buying NEW debt, they were still taking the money they earned on that debt and reinvesting it back into the mortgage/Treasury market. Near the end of 2017, they said they’d be winding down those reinvestments. That winding-down process has affected mortgages more than Treasuries, and is one of the reasons mortgage rates have underperformed Treasuries in 2018.
The good news is that the Fed is essentially done with the winding-down process in mortgages now. This should help slow the pace of mortgage rate underperformance (i.e. the recent trend of mortgage rates rising more quickly than Treasury yields).
Mortgage rates still have to worry about the overall trajectory of the broader interest rate market though! To that end, the mortgage market, the Fed, and the average bond investor are all watching what happens next in inflation. We know wages are stronger than they have been, but traders are waiting for more confirmation that wages will push inflation higher. When we get back from the upcoming 3-day weekend (Veterans Day), we’ll get a key inflation report on Wednesday (Consumer Price Index or “CPI”). This could go a long way in determining whether rates are interested in maintaining their recent ceiling or breaking up to more long-term highs.
October has a bit of a reputation in financial markets as being more prone to volatility than most months. While there are solid theories as to why (earnings, start of Federal fiscal year, seasonal staffing patterns among traders), there’s no solid rhyme or reason as to how the volatility will play out.
This time around, October was horrible for stocks and mixed for bonds/rates. In general, most days saw stocks and rates move lower together, but that changed in a big way this week as markets transitioned into November.
In stark contrast to last week, both sides of the market moved almost exclusively higher. The only exception was the divergent move seen after Friday’s surprisingly strong jobs report.
Strong economic data tends to help stocks and hurt bonds/rates. Why did it hurt stocks this time around? The short answer is that the jobs report was so good that it increased the odds of additional Fed rate hikes. And the stock market doesn’t like rate hikes any more than the bond market!
Investors are already counting on a few more rate hikes by the middle of next year. That means the current trajectory of Fed rate hikes is baked in to current trading levels. If something happens to change the trajectory, trading levels can change fairly quickly, and the jobs report was strong enough to do just that.
What was so good about the jobs report? On a purely objective level, wage growth is the highest it’s been since before the recession. Wages are seen as a key driver of inflation. The Fed is tasked with keeping inflation in check–something it does via rate hikes. Logically then, faster wage growth should steel the Fed’s rate hike resolve.
On a more subjective note (but with objective data to back it up), the pace of job growth has been surprisingly strong lately. The following chart shows the 12-month average of new private sector jobs created. Based on past economic cycles, most investors were expecting to see job growth level-off and hold fairly flat for the next few years.
Instead, job growth has broken higher in a way not normally seen at this phase of an economic cycle. That’s forced traders to make increasingly abrupt adjustments as this weird new reality continues to assert itself month after month. The fallout from such adjustments can be seen in another breakout for interest rates.
The chart above shows 10yr Treasury yields–the most widely followed representation of “longer-term rates” in the US. Of course those of us with a stake in the housing market are generally more interested in mortgage rates.
Unfortunately, the bonds that underlie mortgages don’t cope with volatility as well as plain old US Treasuries. As such, mortgage rates have been underperforming. In fact, the week ended with average 30yr fixed rates at their highest levels in more than 7 years. This assertion is at odds with several mortgage rate headlines from well known publications, and that’s normal. Those publications are relying on survey based data from Freddie Mac which is based primarily on rate quotes from the first 2-3 days of any given week. As such, if there is a big move in the 2nd half of the week, Freddie’s survey might indicate rates moved one direction when they actually moved another.
This week was all about stocks, and if they were going to take any solace from lower rates, they had ample opportunity. Sell-offs of this size are almost always multifaceted issues. So while we can’t say that investors weren’t thinking about rates, we cancertainly say that the average investor was thinking a lot more about other things.
Ranking those “other things” isn’t too important for our purposes today (most would put corporate earnings at the top of the list, if you’re curious). What’s important is that stocks had a big impact on interest rates.
It actually makes a lot more sense for a big stock sell-off to have a direct effect on interest rates. As money flees the stock market, it needs a home–a safe haven in which to weather the storm. The bond market typically soaks up at least some of that safe-haven demand, and higher demand for bonds means lower rates.
The extent to which investors choose the bond market as that safe haven varies greatly. The following charts will examine this phenomenon. First, let’s take a look at just how highly correlated stocks and bonds were this week.
Even when stocks and bonds aren’t moving in relatively perfect unison like this, it’s still fairly common to see general correlation. The entire month of September was a fairly good example.
But the September chart raises an important question: what is correlation when it comes to stocks and bonds? If the two lines are moving in the same direction over a certain amount of time, they’re technically “correlated” during that time. But this says nothing of magnitudes.
To illustrate this point, consider that the y-axis is very different for the two charts above. This past week has seen nearly doublethe movement in stocks, but roughly the same in bonds. That alone tells us the magnitude of the correlation is different, but let’s visualize it! To do that, we can “lock in” the correlation seen back in September and then zoom out to see everything that’s happened since then.
If you look closely, you can see the correlation is still there (i.e. rates are moving lower when stocks are tanking), but the magnitude of the correlated moves varies immensely. The implication is that it will take heavy stock losses on an ongoing basis if we’re to see even a moderate drop in interest rates from here.
One extra layer of complexity comes from the relationship between the rates implied by Treasury yields (seen in the chart above), and those that actually make their way onto mortgage lenders’ rate sheets. Don’t worry, the correlation here is infinitely more well-behaved over time. Case in point:
That said, it can definitely take mortgage rates some time to get caught up with more abrupt movement in the broader bond market. Although mortgage rates did fall nicely on Friday, they didn’t move nearly as much as 10yr Treasury yields over the course of the week. The implication is that if next week begins with stability in bond market, mortgage rates could continue to close this gap in a favorable way.
In housing specific news this week, there were two key reports. The first–New Home Sales–was a bit gloomy. It moved below its supportive trend of growth for the first time in several years.
Mitigating the gloom is the fact that this is a historically volatile set of data that’s often revised. Beyond that, if housing numbers are leveling-off, we should expect uptrends like the one seen in the chart above to be broken in favor of more sideways momentum.
The other housing report was not only more timely (it deals with new purchase contracts as opposed to finalized sales), but also more upbeat. The National Association of Realtors Pending Home Sales Index increased for September, thus suggesting stronger Existing Home Sales in October.
In addition to the modest gains, there’s a hidden message about the housing market’s resilience in the chart. Simply put, mortgage rates have now risen much more overall, and to much higher levels than they did in 2013’s taper tantrum, yet the corresponding drop in Pending Home Sales is significantly smaller. Bottom line: this doesn’t look like a housing market that is interested in panicking.