Events this week

But, as always, there are plenty of other sources of potential volatility. Right now, the unfolding drama of the US-China trade talks is the most obvious. But the possibility of a government shutdown on Dec. 20 may also begin to influence markets more. And, of course, there’s always a chance of some other issue — foreign or domestic — flaring up. Anything that might impact the US economy significantly is likely to affect markets.

Sunday, Dec. 15 was — and may still be — an important day for those US-China trade talks. That’s when the White House was scheduled to impose 15% tariffs on a further $156 billion worth of Chinese imports. But yesterday’s Wall Street Journal reported a possible mini-deal that might see those postponed.

If that turns out to be accurate and such a mini-deal is actually finalized, it would relieve some of the anxieties markets currently have over the trade talks. But there’s a risk investors will grow weary of the constant stream of contradictory reports and statements surrounding this whole topic, and give up reacting to them.

Other days that could bring volatility include Friday, when the UK’s general election result will be known. Such elections often pass unnoticed by American markets. But this one’s tied to Brexit (see below), which could have an impact on our economy.

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.

And there’s been a lot of emerging and receding going on over the last month. Just last week, we witnessed sunny optimism give way to somber pessimism, only for that, in turn, to fade.

Last Tuesday, President Donald Trump told reporters in London concerning the current talks:

I have no deadline. In some ways I think it’s better to wait for after the election, if you want to know the truth.

Now we face a fork in the road this Sunday (see above) at which a new range of tariffs may be introduced. Will we take the path that leads to a return to trade peace or will it be the one that sees escalation? Either way, we may see hope emerging and receding even more frequently this week.

Pain

Right now, many would welcome any signs of this trade dispute heading toward a resolution. 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.

But 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 it’s economy is certainly under strain.

Meanwhile, researchers from University College London and the London School of Economics calculate the average American family will pay about $460 a year in higher prices as a result of the tariffs implemented so far.

Higher prices for American families

A later (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.” That, the Foundation suggested, would rise to $3,614 a year if all the administration’s currently proposed tariffs were implemented. 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%.

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. Separately, he told CBS Moneywatch that “some 450,000 fewer jobs will be created by year-end” if current tariffs remain in place and new ones are implemented on schedule.

And on Dec. 3, the U.S. Solar Industries Association (not a disinterested party) said, “tariffs on imported [solar] panels will cost the United States 62,000 jobs and $19 billion,” according to Reuters. The White House (also not a disinterested party) disputed the figures.

Of course, unemployment is already 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 digital services tax. That is intended to raise revenues from technology companies, frustrating their use of artificial tax avoidance methods. But, of course, many of those companies are American, which is why the president sees the tax as a hostile act. Several other countries have plans for a similar tax.

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.

These moves follow a World Trade Organization (WTO) ruling on Oct. 2 on a 15-year dispute over subsidies given to airplane manufacturers Boeing and Airbus. This decision found that EU subsidies had been unfair. A ruling on US subsidies for Boeing is expected in 2020.

More?

On Dec. 2, President Trump tweeted:

Brazil and Argentina have been presiding over a massive devaluation of their currencies. which is not good for our farmers. Therefore, effective immediately, I will restore the Tariffs on all Steel & Aluminum that is shipped into the U.S. from those countries.

Some in the media are lumping this in with the new tariffs against France and some pessimistic remarks the president’ made in London on the US-China trade talks. Last week, commentators were referring to a return of “The Tariff Man,” a term President Trump used to describe himself last year.

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.

Impeachment

Yesterday, Democrats in the House of Representatives announced two articles of impeachment against President 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.

However, the Times went on to warn that the knock-on effects could become more sustained and damaging. That might arise if the president uses escalations in the trade war with China to distract voters from proceedings in Congress.

Alternatively, the Times speculated, the effects might be benign if they mean he personally is distracted by the process and loses focus on trade. Remember, those who want lower mortgage rates need bad news.

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.

“Inverted yield curve” is easy to understand

You’ve probably read a lot of headlines recently about the “inverted yield curve.” But it’s the sort of impenetrable jargon that most of us skip over on the grounds life’s already too short.

But hold on! It’s actually easy to understand. It simply means that short-term US Treasury bills, notes and bonds are giving higher yields than long-term ones. Yes, that’s rare. You usually expect to get a better return the longer you commit to an investment.

It’s also a little scary. Frequently, in the past, when the yield curve has inverted, a recession has soon followed. That doesn’t mean it will this time. But it’s a bit worrying.

Critical yield curve inverted

Any time yields are lower on longer-term bonds than shorter ones, that’s an inversion. But it’s when the 2- and 10-year Treasury yields (the return you get on those US government securities) invert that has proved to be the most reliable — close to infallible — predictor of recessions.

And those two hadn’t crossed the line since June 2007 — until mid-August this year. Since then, they’ve crossed and recrossed it a number of times.

Unless you’re in hiding, you can’t have missed the resulting doom-laden media reports, full of dire predictions. In fact, right now, there are few other noticeable signs of a recession looming. And some say fears are overblown.

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. However, it now seems safe to relegate it to a much less important influence.

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. And, so far, successive governments and parliaments have found it impossible to identify a formula that most legislators could support.

What looks likely to happen over Brexit

The UK is currently in the midst of a general election campaign, culminating in a vote tomorrow (Dec. 12). And the result, which will be known on Friday, could impact American mortgage rates if it’s unexpected, though probably only briefly.

Right now, the incumbent Conservative party has a comfortable but narrowing lead in the polls. However, the British electoral system means such a lead may not be as decisive as the figures suggest. And there’s no guarantee an electorate that’s as equally divided and partisan as the politicians won’t return another “hung parliament,” meaning one in which no party has an overall majority. That could make the deadlock even worse. And there’s a chance there might yet be a second referendum.

But, for now, the likelihood is that we’ll see an intermission in the long-running Brexit saga while the UK tries to find a way to break its political impasse. It may be early in 2020, if not later, before Brexit affects American mortgage rates again.

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.