Today’s drivers of change

The Middle East

A targeted US drone strike killed Iranian General Qasem Soleimani early last Friday. And markets responded nervously when they opened later that day. That meant higher gold and oil prices and lower US Treasury yields and stock indexes. The same may happen again today. But read on to discover why that’s far from certain.

Yesterday, Iran retaliated, launching 12-30 (reports vary) ballistic missiles at two bases with a US presence in Iraq. Some sources in the government in Tehran have indicated that yesterday’s attack is the only reprisal it requires. And they say Iran’s prepared to draw a line under Friday’s incident, providing the US doesn’t escalate the dispute further.

However, Iranian government communications are far from coherent. And some experts doubt that policy (if it is one) will apply for long.

What next?

At the time of writing, US and coalition deaths and casualties resulting from yesterday’s attack are reported as zero. And some speculate that Iran designed its attack to harm as few American personnel as possible. Indeed, the Iraqi prime minister this morning said that the Iranians had warned him in advance about the strike, and that he had passed on the information to the military.

The White House has been uncharacteristically silent on events. But the president is scheduled to comment, perhaps through a TV address, at 11 a.m. (ET). What he says then will be critical, not only for millions in America and the Middle East, but also for markets and mortgage rates.

Before the attack, President Trump was bellicose and warned that his reaction to any retaliation could be “disproportionate.” But, given the lack of harm to Americans and Iraq’s apparent willingness to draw a line under recent events, he may feel able to de-escalate.

If, the president indicates that his policy is one of de-escalation, then markets could bounce back quickly. We might even see mortgage rates rise, possibly appreciably. But, if he feels obliged to escalate, a worthwhile fall could be on the cards. While they wait for his remarks, markets are barely moving.

Short-lived?

Markets often bounce back rapidly from such crises, once they appear resolved. Indeed, they seemed yesterday to have largely moved on, though that was before Iran’s missile strike. And on Monday morning, CNN Business quoted UBS Wealth Management’s chief investment officer Mark Haefele:

Geopolitical events by their nature are unpredictable, but previous periods of increased tensions suggest that the impact on wider markets tends to be short-lived.

However, if the president decides to escalate, markets are likely to remain bad (and mortgage rates good) for as long as the actions and reactions last.

Trade

Some are reporting that recent stock-market highs have partly been fueled by renewed optimism over the prospects for a trade deal with China. And that optimism may be boosted by President Trump’s announcement on Dec. 31 that his phase-one deal will be signed on January 15.

But, last Monday morning, The Financial Times ran an analysis under the headline, “Market faith in US-China trade deal is misplaced.” And the current edition of The Economist notes:

The “phase one” agreement trims tariffs and obliges China to buy more from American farmers. But do not be fooled. It is a modest accord that cannot disguise how the world’s central relationship is at its most perilous juncture since before Richard Nixon and Mao Zedong reestablished links five decades ago.

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.

Phase-one trade deal

And, on Dec. 13, a form of resolution seemed to be reached with the unveiling of that phase-one deal. Yet most markets didn’t respond by soaring, as you might have expected. Instead, ones that affect mortgage rates moved modestly lower. So why is that?

Well, mainly for four reasons:

1. The phase-one deal is yet to be signed. Yes, a date (Jan. 15) has now been set for the signing. But we’ve been here before
2. The rollback of existing tariffs is modest. Yahoo! Finance estimated 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 and business practices

Those doubts were enough to stop markets celebrating. Still, it’s true that some tariffs have been abandoned and that China has promised to buy more farm produce from us. And both those are 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, the Dec. 13 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 Trump was inaugurated.

And this dispute has been causing some pain to both sides. China’s slipped to third place from first in the Census Bureau’s 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 that figure.

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 eventually moderate that figure. But it’s unlikely to make big inroads.

Yes, unemployment is already at a near-record low. But it could be even lower (and wages higher, based on The Tax Foundation’s figures) 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. Together, its member states form a larger economy than China or even America.

But, on Dec. 17, US trade representative Robert Lighthizer made an ominous remark. He said that President Trump is now “focused” on trade with the EU. The Financial Times that day interpreted the comment as meaning “the Trump administration was ready to escalate its trade confrontation with the EU

The administration has already in 2019 imposed tariffs on nearly $10 billion worth of imports from the EU, including $2.4 billion on French luxury goods in December.

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 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 the Dec. 13 phase-one deal turns out 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.

What 2020 might hold

The year 2019 ended with most stock indexes at exceptional or record highs. And investors have had one of the best 12 months in living memory. So will 2020 bring more of the same?

Few think it will. But most economists, analysts and observers seem to believe we’re looking at an OK year. Certainly, fewer are expecting a recession during the period than was the case a few months ago. When Reuters polled economists in November, only 25% thought one was likely, down from 35% in October.

But Reuters’ December poll saw a consensus of the economists who responded forecasting disappointing growth in gross domestic product (GDP) this year. Indeed, most expected it to be in a range between 1.6%-1.9% between now and mid-2021.

And a number of financial reviews of 2019 have warned that markets have largely been fueled by the Federal Reserve’s actions rather than underlying economic strength. But the Fed’s supply of metaphorical gas to maintain such momentum is running low — as is its willingness to use what’s left.

So market growth this year may be way more modest than in 2019, though many reckon it will remain positive. Monday morning’s Financial Times carries an analysis under the headline, “Fed looks forward to ‘boring’ 2020 after frenetic year.”

Don’t take forecasts too seriously

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.

Lower mortgage rates ahead?

It’s not hard to find experts who predict that mortgage rates could plumb new depths in 2020. And they may be proved right.

A recession still might arise. The US-China trade talks could collapse and the dispute escalate. Some undreamed-of crisis could come out of nowhere. Indeed, last Friday’s killing of an Iranian general may turn out to be the start of just such a crisis. Any of those could send those rates plummeting.

Just don’t forget John Kenneth Galbraith’s observation.

Rate forecasts for 2020

It may be a mistake to rely on experts’ forecasts. But there’s nothing wrong with taking them into account, appropriately seasoned with a pinch of salt. After all, who else are we going to ask when making plans?

Fannie Mae, Freddie Mac and the Mortgage Bankers Association (MBA) each has a team of economists dedicated to monitoring and forecasting what will happen to the economy, the housing sector and mortgage rates. And here are their latest forecasts, all published in December, for each quarter (Q1, Q2 …) in 2020 of the average rate for a 30-year, fixed-rate mortgage:

Freddie Mac reckons that particular mortgage rate averaged 3.9% during 2019. So, if the experts’ forecasts turn out to be right, it could be another good year for new mortgage borrowers — and for existing ones who want to refinance.

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.

But don’t think there isn’t a wider price to pay for ultralow mortgage rates. On Dec. 18, The New York Times reported that, in much of Europe, these are “driving a property boom that is pricing many residents out of big cities and causing concern among policymakers.” And many fear a bubble that could end badly.

Impeachment

On Dec. 18, in a vote almost wholly along party lines, the House of Representatives passed two articles of impeachment against President Trump. One is for abuse of power and the other for obstruction of Congress.

What happens next is unclear. House Speaker Nancy Pelosi has said that she is holding off on sending the matter to the Senate for trial, at least until that chamber decides on how it will structure its procedures. And some Democrats suggest holding them back through to the November 2020 election. You may think it unlikely that either article will survive a trial in the current 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.

Meanwhile, on Dec. 19, the Times reiterated that view:

… the stock market has been largely unfazed by the news of impeachment proceedings, and that is unlikely to change …

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 UK general election on Dec. 12 delivered a majority for Prime Minister Boris Johnson that pretty much assures that Brexit will become law during January or very soon thereafter. That will be followed by a transitional period that will last at least until the end of 2020.

What happens after that could have a huge impact on the British and global economies. But, absent unforeseen upheaval, Brexit now looks unlikely to exert much influence on American mortgage rates, at least until late in the year.

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, on Jan. 3, those yields fell nearly 9 basis points (a basis point is one hundredth of one percentage point). But average mortgage rates inched down by only 1 basis point.

Indeed, divergences have become routine.

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.

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.