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In both cases, breaking news about the US/China trade deal was at the scene of several of the biggest swings. That was especially apparent in wee hours of Thursday morning when China’s Commerce Ministry claimed both sides had agreed to cancel a certain amount of existing tariffs as a part of the deal and that both sides had been in close communication.
The reaction in stocks and bonds was obvious. As we should expect, news that improves the outlook for US/China trade relations (or that simply speaks to tariffs going away) pushes stock prices and bond yields (aka “rates”) higher. Notably though, rates continued drifting higher even as stocks flattened out.
The divergence between stocks and bonds in the chart above can be hard to see. The following two charts examine specific pockets of time on November 7th where it was most obvious.
If we know the trade news was the motivation for the initial volatility and we know stocks and bonds are equally likely to react to it, we’re forced to conclude that the additional movement in bonds is due to something else.
While the trade deal is definitely the spark behind Thursday’s drama, other considerations have acted as dry powder for interest rates. By far the biggest of those considerations is the bigger-picture trend in the bond market. The way it works is surprisingly basic.
In general, bonds/rates have been doing so well for so long that they risk bouncing simply because we’re running out of past precedent that suggests the good times can continue to roll. If that doesn’t sound like an actual justification for trading momentum, it absolutely is! I you’ve ever heard the terms ‘overbought’ or ‘oversold,’ those are fancy ways to refer to the same phenomenon. Traders refer to such motivations as “technical.”
Technical motivation can play out differently depending on the market in question. Unlike the stock market, which has proven itself capable of rallying for more than 2 years without major incident (most recently from April 2016 until the end of 2018), the bond market rarely strings together more than a year of strong momentum without some sort of reset–especially when the year in question has covered as much ground as this one.
The chart below shows these ebbs and flows. The green numbers list the length of time (in months) that a rally trend has lasted and the amount of ground it has covered in terms of 10yr Treasury yields. Vice versa for the red numbers. Mortgage rate movement has been a bit different than Treasury yields, but the latter is what sets the tone for these bigger picture shifts.
If you were hoping to see rates continue lower in 2019, this chart should scare you. The peak to trough improvement already matches the best example from the past decade (2011) and the length of time is certainly on the higher end of the spectrum. Granted, we can count the bounce in rates that’s already taken place over the past 2 months, but even then, we’d still have another 0.1% to go before matching even the gentlest example from the past.
Does this mean rising rates are a sure thing and a done deal? No one will ever be able to tell you such things with certainty. Past precedent is great until it’s not anymore. The best bet is to prepare for the worst and hope you don’t see it. At the very least, people with loans in progress, or those who are on the verge of buying or refinancing, should probably try to get that done sooner than later.
On a final note, if you read other news this week that suggested mortgage rates were LOWER and are wondering why I’m telling you they’re higher, that’s because they’re wrong and I’m right. And it’s all just a big misunderstanding.
Look closely at those articles claiming lower rates and you’ll see they are citing Freddie Mac’s weekly rate survey. There’s nothing wrong with Freddie’s data if you’re only looking for a rough overview of rate trends over super long-term time horizons. For day to day moves, however, their methodology can create a lot of confusion.
Freddie’s survey only accepts responses through Wednesday morning, but our vast experience comparing Freddie’s numbers to actual rate sheets suggest the survey is mostly measuring rates that were available from Friday afternoon through Monday afternoon. As such, the more things move on Tuesday through Friday morning, the farther from reality the survey can be by the time it’s released on Thursday morning. Simply put, rates moved up to 3-month highs this week, NOT back down to 3-week lows.
Not even a little bit. It is true that the Fed cut its policy rate this week. And you’ve no doubt heard newscasters refer to that as “a rate that affects a wide variety of consumer loans.” But apart from certain Home Equity Lines of Credit (HELOCS), the Fed Funds Rate has no direct bearing on longer-term mortgage rates.
Why did rates drop right after Fed day then?
First off, if the Fed rate cut were a big deal for the bond market (which underlies mortgage rates), we would have seen a big, immediate reaction in bonds. We didn’t…
Instead, bonds weakened slightly in the 30 minutes following the Fed’s rate cut. It wasn’t until markets got clarity on the Fed’s policy path that things began to improve. And EVEN THEN, the improvement related to Powell’s press conference was dwarfed by that seen the following morning.
The stock market can actually help us make more sense of the movement in bonds (aka “rates”). Both stocks and bonds like a friendly Fed. With Powell being perceived as friendlier than expected, both stocks and bonds improved (orange line moved higher and blue line moved lower in the following chart on “Fed day”).
Then notice how the orange line (stocks) reverses course and heads lower the next morning in the “weak data” box. This had to do with a report that Chinese officials cast doubt on the viability of the US/China phase 1 trade deal. The move was exacerbated by an exceptionally weak economic report from the Institute for Supply Management-Chicago (Chicago PMI).
The big drops in the orange and blue lines inside the “weak data” box coincide exactly with the trade deal headline and the Chicago PMI data (which is seen as an advance indicator for other key economic reports). Because stocks were falling at the same time, it confirms the source of the movement was the downbeat data and not some after-effect from Fed day.
Stocks and bond yields ended the week by moving higher on Friday. This was partly due to a stronger-than-expected jobs report, but that was actually more of a benefit to stocks. Bonds were fairly undecided until the ISM Manufacturing data was released (one of those important reports for which Chicago PMI is an advance indicator). While the ISM number was indeed weaker than expected, it didn’t miss the mark by nearly as much as the Chicago number. The result was a modest increase in yields.
Despite the weakness on Friday, rates did very well overall this week, and that couldn’t have come at a better time. Just last week we were forced to discuss a fairly gloomy outlook when we asked if it was time to start worrying about rising rates.
In fact on Thursday alone, rates dropped at their fastest single day pace since March 22nd. To be fair, many lenders adjusted rate sheets on Wednesday afternoon, but even if we consider a 48 hour time frame for mortgage rate movement, changes of that magnitude (about an eighth of a percentage point or 0.125%) are rare. In fact, more often than not, entire weeks go by without a 0.125% change in average 30yr fixed rates.
The size and speed of the move is interesting in and of itself, but it’s made more interesting by the fact that this week’s most prevalent mortgage rate headlines claimed that rates were actually HIGHER. Rest assured, that’s not the case. So what’s with the misleading headlines?
This is actually a fairly common occurrence. It stems from the fact that the industry’s longest-standing and most widely-cited mortgage rate barometer–Freddie Mac’s weekly rate survey–is only updated once per week. Moreover, Freddie’s weekly rate is announced on Thursday morning whereas the data is primarily collected on Monday and Tuesday. The last 2 days of the week aren’t even counted.
All of the above means that any significant movement in rates in the 2nd half of any given week can create a big discrepancy between Freddie’s numbers and reality. The differences are only more pronounced if rates were moving in the opposite direction heading into the first part of the week, which is exactly what happened this time around.
In other words, Monday–the day that gets the most weight in Freddie’s survey–saw the highest rates of the current week. They didn’t fall much on Tuesday or Wednesday, which is the last possible opportunity for rate quotes to make it into Freddie’s survey. As such, the survey logically conveyed “higher mortgage rates this week” just in time for lenders’ actual rate sheets to show the huge improvement.
In addition to the welcome developments in rates, a key housing report out this week showed the highest levels of Pending Home Sales since the end of 2017 and the fastest annual growth since 2015.
Surging sales, and big drops in mortgage rates! Are we out of the woods with respect to last week’s doom and gloom? Ah… it would be great if anyone could accurately predict that future, but the market remains beholden to data and events that have yet to occur. Sure, analysts can guess at how things might happen, but the market simply adjusts itself to account for those guesses anyway. The best we can do is understand the future in “ifs” and “thens” based on what markets say is important to them.
If we zoom out the stock/bond chart to a slightly wider time frame, we only get more evidence that economic data and the trade war are hot topics. Events like Brexit and other geopolitical considerations will also flare up and offer some input from time to time, but these are generally supporting actors next to the state of the global economy.
If we look at the super long term chart of 10yr yields (a proxy for momentum in longer-term rates like 30yr fixed mortgages), we see a refreshing trend is not only intact, but that rates may be on the move to the most exciting side of the ‘railroad tracks.’
Lest we get too excited about such things, it will serve us well to keep last week’s cautionary message in mind. We do indeed need to remain vigilant about the risk of a rising rate trend taking root. We certainly managed to avoid confirming such things this week, but if we apply a few other lines to the chart above and zoom in on the last 10 years, we find cause for concern in 2019 being potentially one of only a few big turning points where rates surged to long-term lows and then began a relatively unpleasant move higher.
The uniqueness of the rally makes it hard to say exactly what might happen next. In fairness, that’s always hard when it comes to financial markets. The market has a nasty tendency to go out of its way (or so it would seem) to prove people wrong just when they think they have things figured out.
I’m speaking in generalities here, but there is hard math underlying the point (or a hard hypothesis anyway) known as the Efficient Markets Theory. In a nutshell, it says asset prices (like those for the bonds that determine interest rates) reflect everything that can be known about them today. Therefore, they will only react to genuinely NEW information.
To make matters even more uncertain, a lot of time, effort, and money go into trying to predict what that new information will be. Those predictions in turn become part of “everything that can be known today.” What that means, in essence, is that you’d actually have to predict something that no one else can predict in order to get a leg up on future potential movement in stocks, interest rates, etc.
What we can do is talk about what we’re already seeing in the charts and what the implications MIGHT be. This can help us prepare for risks and opportunities associated with various outcomes.
Many rate watchers are keeping a close eye on the breakdown of the long-term rally trend as it relates to moving averages and simple trend lines. A moving average is just that: the average rate on any given day for the past x number of days.
Some market watchers believe moving averages hold power to act as floors, ceilings, or indicators of an impending shift. But for any prediction someone might make based on a moving average, there are plenty of past examples where the opposite held true.
What a moving average CAN do for us, however, is serve to emphasize the point that a particular trend is “having second thoughts,” as it were. The following chart shows one way to look at this with a quarterly moving average (the average 10yr yield for the preceding 3 months). The first “failed breakout” could also be seen as the first instance of “second thoughts.” Some would see the “more sustained breakout” as evidence that the 2019 rally may be over.
The next chart provides another way to essentially arrive at a similar conclusion. The consolidation pattern that came into focus over the past few months is the most pronounced of its kind in 2019. These pennant-shaped patterns of lower highs and higher lows often emerge when investors are pumping the brakes on the prevailing trend.
And that’s really the only thing such patterns tell us. They do not, for example, imply the size and direction of the next move. That said, breaking out from the upper line is logically more discouraging for fans of low rates than breaking the lower line. If we think of the two red lines as competing trends, this is like saying the trend toward higher rates (represented by the lower red line in the chart below) is “the winner.”
While neither of the above charts predict a bleak future for rates, they can serve to remind us of that possibility. Indeed, few instances of downward movement in rates have covered as much ground or lasted as long as 2019’s example. But remember, if we look back far enough, we can usually find examples that argue the other side of the point.
So if you’re not ready for rates to move higher yet, then root for a 2011 type of scenario where rates stayed sideways in a volatile range through the middle of the following year before ultimately going LOWER. Without the benefit of the following charts axis labels, it would be easy to mistake it for 2019.
What’s the point of all this? Mostly just to advocate against complacency after an awesome run for rates. As always, the uncertain outcomes of data and events in the coming months have the best chance to set the tone. These include economic data at home and abroad, US/China trade relations, Brexit developments, geopolitical developments, and the global central bank response to all of the above.
Speaking of central bank responses, next week brings yet another installment of the latest policy announcement from the Federal Reserve. As you may have heard, the Fed is almost certain to cut rates yet again. If you think that’s great news, think again! Remember that Efficient Market Theory discussed above.
Financial markets have already assumed and acted upon the probability of next week’s Fed rate cut. That means any effect it would have on mortgage rates has already been felt (mortgage rates can move daily whereas the Fed only changes its rate once every 6 weeks). If you need more convincing, just revisit THIS NEWSLETTER from a few weeks back.