Today’s drivers of change

Trade

Most sharp movements in mortgage rates in recent months have been down to alternating optimism and pessimism over the US-China trade dispute. Indeed, that dispute has probably been the main driver of changes in most markets as they’ve moved in line with emerging and receding hopes of a resolution.

Last Friday, a form of resolution seemed to be reached. And yet markets didn’t respond by soaring, as you might have expected. Instead, ones that affect mortgage rates moved modestly lower. And they barely moved on Monday. So why was that?

Well, mainly for four reasons:

1. The phase-one deal is yet to be signed. And we’ve been here before
2. The rollback of existing tariffs is modest. Yahoo! Finance estimated on Monday that tariffs on imports from China would be down only 11% after the deal is implemented
3. Much of the detail of what it contains remains unclear
4. Based on what is known, some doubt that it addresses properly the things that bother the US most about China’s trade practices

Those doubts were enough to stop markets celebrating exuberantly. Indeed, by Monday evening, they’d hardly reacted at all. But the facts that new tariffs have been choked off and China has promised to buy more American farm produce is good for American consumers and farmers.

Pain

Regardless of day-to-day dramas, many would welcome any signs of this trade dispute heading toward a genuine resolution. True, Friday’s deal, if signed, has headed off new tariffs and rolled back at least some (perhaps 11% of) existing ones. But the situation before it was challenging.

A new round of American tariffs on Chinese goods became operative on Sept. 1. The Peterson Institute for International Economics reckoned that brought the average US tariff on imports from that country to 21.2%, up from 3.1% when President Donald Trump was inaugurated.

And this dispute has been causing some pain to both sides. China’s slipped to third place from first in the list of America’s trading partners. And its economy is certainly under strain. But the dispute’s impact here has also been painful for many.

Higher prices for American families

A September study by the nonpartisan National Foundation for American Policy estimated, “the tariffs will cost the average household $2,031 per year, and will be recurring so long as the tariffs stay in effect.” The White House would undoubtedly challenge all those figures.

But, on Dec. 2, New York Federal Reserve Bank researchers published a report that showed that American businesses and consumers were indeed bearing the brunt of the tariffs. They found Chinese import prices fell by only 2% between June 2018 and September 2019. And that means Americans were picking up the rest of the tab on tariffs as high as 25%.

Of course, both those studies were conducted before the new phase-one deal was announced. If that’s signed, you can shave perhaps 11% off that $2,031 cost to the average American household.

Jobs at risk

As bad, on Nov. 22, Moody’s Analytics’ chief economist Mark Zandi published a report suggesting that the US economy had lost 300,000 jobs as a direct result of this trade dispute.

Again, the new phase-one deal may moderate that figure. But it’s unlikely to make big inroads.

Still, unemployment is already, of course, at a near-record low. But it could be even lower (and perhaps wages better) absent the US-China dispute.

European Union next?

The president occasionally makes bellicose remarks about what he perceives to be an unfair trade imbalance between the US and the European Union. The EU is the world’s biggest trading bloc. But on Dec. 2, the US trade representative announced real plans to introduce tariffs on an EU member state.

The proposal would see those new tariffs levied at a rate of 100% on $2.4 billion of French goods, including Champagne, other wines, cheese and luxury goods. The move is in retaliation for France’s new digital services tax. That is intended to frustrate technology companies’ exotic (but legal) tax-avoidance gambits by taxing them at a low rate on their turnover within the country rather than the profits they choose to declare there.

But, of course, many of those companies are American, which is why the president sees the new tax as a hostile act. Several other countries have plans for a similar tax.

In addition, on October 18, the US imposed tariffs on goods worth $7.5 billion from European Union (EU) countries. In response, the EU introduced import duties of 25% on American goods worth $2.8 billion. That was down to a 15-year squabble over subsidies to airplane manufacturers.

How trade disputes hurt

All this has been fueling uncertainty in markets. And that, in turn, is creating volatility. Many of the recent wild swings in mortgage rates, bond yields, stock markets, and gold and oil prices have been down to hopes and fears over trade.

Markets generally hate trade disputes because they introduce uncertainty, dampen trade, slow global growth and are disruptive to established supply chains. President Donald Trump is confident that analysis is wrong and that America will come out a winner.

However, some fear a trade war — possibly on two or more fronts — might be a drag on the global economy that hits America hard. And that fear, in turn, is likely to exert long-term downward pressure on mortgage rates, relieved only by hopeful news.

For the sake of the economy, we must hope that Friday’s deal is better than some expect — and that it’s eventually signed. But those who want lower mortgage rates may be disappointed if those wishes come true before they lock.

Brexit

Having won the UK general election with a handsome majority last week, British Prime Minister Boris Johnson plans to push ahead with Brexit quickly. His Withdrawal Agreement Bill, which enables the deal he struck with the EU in October, will be laid before the House of Commons on Friday.

Yesterday, Johnson announced that the bill would be revised to outlaw any extension to the final withdrawal date of the end of 2020. That gives the UK and EU only a year to negotiate a trade deal. If they fail to agree one in that short period, a “no-deal Brexit” (the version that almost all economists warn would be devastating to the UK economy and harmful to the global one) might be hard to avoid. Markets reacted badly to the news.

Friday’s the beginning of the process of enactment. And, while Johnson hopes that process will be short, his bill could meet opposition in the House of Lords.

But don’t be gulled by analogies between that house and the US Senate. The former can only review legislation, suggest amendments and delay bills. In the end, the Commons has the only real say, under a constitution that’s based on the principle of the “fusion of powers.” So Brexit is as close to certain as anything can be.

What is Brexit?

For the first time since 2016, Brexit was playing a major role in the determination of American mortgage rates during part of October. Brexit is Britain’s exit from the European Union (EU) after 46 years of membership of the world’s largest trading bloc.

A nonbinding (advisory) referendum in June 2016 saw a small majority of voters in favor of leaving. But the simple in-or-out question disguised a vastly nuanced series of issues that made it impossible for legislators to find a compromise that a majority could support. And only now, following last week’s election, has that legislative logjam been broken. Markets are generally happy.

What looks likely to happen over Brexit

But there’s a paradox here. Global markets would probably prefer there to be no Brexit at all. Many see it — and especially a no-deal version — as an epic act of national self-harm that could impact the world economy.

But they’re so fed up with the long period of uncertainty (41 months so far) since the referendum that they’d rather see the process finished than wait longer. Last Friday, JPMorgan’s head of global currency strategy Paul Meggyesi summed this up:

The market is in danger of conflating the removal of political uncertainty with the reversal of the economic impact of Brexit. That strikes us as being highly optimistic verging on the implausible.

Impeachment

Democrats in the House of Representatives are moving forward with two articles of impeachment against President Donald Trump. One is for abuse of power and the other for obstruction of Congress. You may think it unlikely that either will survive a trial in the Republican-dominated Senate.

On Sept. 25, The New York Times suggested moves in the House to impeach the president may have only a limited effect on markets. It used the word “fleeting” to describe the probable impact. And, at least so far, its prediction seems to be holding up, in spite of some dramatic scenes on Capitol Hill.

Treasurys and mortgage rates

Why are mortgage rates currently so often out of sync with the markets they usually shadow? After all, markets are generally interdependent.

During economically worrying times (the opposite happens when confidence is high), investors sell stocks because they fear a downturn. But they have to put their money somewhere. So they buy lower-yield but safer “risk-off” investments, such as US Treasurys, gold and mortgage-backed securities (MBSs).

MBSs are bundles of individual mortgages, wrapped up within a bond-like “security” (a tradable financial asset) and sold on a secondary market. And, the more investors want to buy them, the lower the mortgage rate you’re likely to be offered.

Markets in sync

Usually, the flows of money are fairly even across risk-off markets. So you can typically assume that gold and bond prices will go up or down roughly in line both with each other and inversely with falling or rising stock prices.

And the same applied to MBSs. In fact, the relationship between 10-year Treasury yields and mortgage rates was for years so close that many (wrongly) assumed the two were formally linked.

Why the change?

But nobody could make that mistake now. For example, between our report on the morning of November 1 and markets closing on the afternoon of the next business day, those yields climbed to 1.79% from 1.70%. But average mortgage rates edged up by only 2 basis points (a basis point is one hundredth of one percentage point) across those two trading days.

Indeed, on Nov. 21, those yields edged up, even as average mortgage rates moved down.

So why are the MBSs that actually determine mortgage rates drifting apart from risk-off investments generally and those Treasury yields in particular? There are three main reasons:

1. Investors are concerned they’re not being rewarded sufficiently for the extra risk they shoulder when they buy MBSs rather than Treasury bonds. In particular, the US Treasury never welshes or redeems its bonds early, making those ultrasafe and predictable. Meanwhile, mortgage borrowers often refinance and occasionally default
2. Some are worried about government reform of Fannie Mae and Freddie Mac. On Oct. 28, National Mortgage Professional magazine suggested, ” … we have now seen the implementation of the first steps, some of which have only increased market volatility.”
3. The things that spook or please investors in Treasury bonds don’t always apply to mortgage-backed securities

And another factor affects mortgage rates rather than MBSs themselves. Mortgage lenders are distrustful of extreme volatility and often take a wait-and-see stance before adjusting the rates they offer

Forecasting issues

Those Treasury yields are one of the main indicators (see the “market data” list above for others) we use to make predictions about where rates will head. And, with those tools more unreliable than usual, we sometimes struggle to get our daily predictions right. Until the relationship between rates, yields and other indicators gets back in sync, you should bear that in mind.

Lower rates ahead?

On Sept. 6, CNBC ran a studio interview with Bob Michele, CIO of J.P. Morgan Asset Management. In that interview, Michele predicted that the yield on 10-year Treasurys would hit zero before the end of this year.

On the same day, Lawrence Yun, the National Association of Realtors chief economist, said he could envisage a new record-low mortgage rate of 3.3% — also before the end of this year.

By all means, take cheer from these predictions. But never forget a remark made by the late Harvard economics professor John Kenneth Galbraith:

The only function of economic forecasting is to make astrology look respectable.

Certainly, the recent pattern of rises and falls suggests an uneven path, even if those prognosticators are ultimately proved right. And, with the New Year looming, they’re running out of time.

Negative mortgage rates

Just don’t expect zero or negative mortgage rates in America anytime soon. Still, they’re not unthinkable within a year or two.

Already, Denmark’s Jyske Bank is offering its local customers a mortgage with a nominal interest rate of -0.5%. Yes, that’s 0.5%. However, after fees, that’s likely to be closer to a free or incredibly cheap mortgage than one that actually pays borrowers.

Rate lock recommendation

We suggest

We suggest that you lock if you’re less than 30 days from closing. Some professionals are recommending locking even further out from closing. And we wouldn’t argue with them.

However, that doesn’t mean we expect you to lock on days when mortgage rates are actively falling. That advice is intended for more normal times.

Of course, financially conservative borrowers might want to lock immediately, almost regardless of when they’re due to close. After all, current mortgage rates remain exceptionally low and a great deal is assured. On the other hand, risk-takers might prefer to bide their time and take a chance on future falls. But only you can decide on the level of risk with which you’re personally comfortable.

If you are still floating, do remain vigilant right up until you lock. Continue to watch key markets and news cycles closely. In particular, look out for stories that might affect the performance of the American economy. As a very general rule, good news tends to push mortgage rates up, while bad drags them down.

When to lock anyway

You may wish to lock your loan anyway if you are buying a home and have a higher debt-to-income ratio than most. Indeed, you be more inclined to lock because any rises in rates could kill your mortgage approval. If you’re refinancing, that’s less critical and you may be able to gamble and float.

If your closing is weeks or months away, the decision to lock or float becomes complicated. Obviously, if you know rates are rising, you want to lock in as soon as possible. However, the longer your lock, the higher your upfront costs. On the flip side, if a higher rate would wipe out your mortgage approval, you’ll probably want to lock in even if it costs more.

If you’re still floating, stay in close contact with your lender, and keep an eye on markets.

My advice

Bearing in mind professor Galbraith’s warning, I personally recommend:

• LOCK if closing in 7 days
• LOCK if closing in 15 days
• LOCK if closing in 30 days
• FLOAT if closing in 45 days
• FLOAT if closing in 60 days

But it’s entirely your decision.

What causes rates to rise and fall?

Mortgage interest rates depend a great deal on the expectations of investors. Good economic news tends to be bad for interest rates because an active economy raises concerns about inflation. Inflation causes fixed-income investments like bonds to lose value, and that causes their yields (another way of saying interest rates) to increase.

For example, suppose that two years ago, you bought a $1,000 bond paying 5% interest ($50) each year. (This is called its “coupon rate” or “par rate” because you paid $1,000 for a $1,000 bond, and because its interest rate equals the rate stated on the bond — in this case, 5%).

• Your interest rate: $50 annual interest / $1,000 = 5.0%

When rates fall

That’s a pretty good rate today, so lots of investors want to buy it from you. You can sell your $1,000 bond for $1,200. The buyer gets the same $50 a year in interest that you were getting. It’s still 5% of the $1,000 coupon. However, because he paid more for the bond, his return is lower.

• Your buyer’s interest rate: $50 annual interest / $1,200 = 4.2%

The buyer gets an interest rate, or yield, of only 4.2%. And that’s why, when demand for bonds increases and bond prices go up, interest rates go down.

When rates rise

However, when the economy heats up, the potential for inflation makes bonds less appealing. With fewer people wanting to buy bonds, their prices decrease, and then interest rates go up.

Imagine that you have your $1,000 bond, but you can’t sell it for $1,000 because unemployment has dropped and stock prices are soaring. You end up getting $700. The buyer gets the same $50 a year in interest, but the yield looks like this:

• $50 annual interest / $700 = 7.1%

The buyer’s interest rate is now slightly more than 7%. Interest rates and yields are not mysterious. You calculate them with simple math.