After a wild Friday and an even wilder weekend, we're off to a good start
Friday held many ups and downs for the Mortgage Backed Security (MBS) market, which have a direct effect on interest rates. Mostly this was a big "up" in the morning, followed by a big "down" that stabilized into the afternoon. All in all, no ground was lost in terms of rates.
This weekend's economic news was huge:
- The Federal Reserve announced a cut to the discount window of .25, a move not seen since 1979.
- A Term Lending Facility was created by the FED, which is basically a drive-thru window for big banks, most of whom trade Mortgage-Backed-Securities. This eases liquidity concerns, which is a positive for rates.
- Bear Stearns, facing bankruptcy, was purchased by JP Morgan Chase with help and assurances from the fed. This swift move, although stemming from financial weakness, actually helps mortgage rates due to the fact that Bear's demise was less grizzly than it could have been. This adds a degree of calm to the herd (investors), and makes it easier for them to consider crossing the savannah (keep money in Mortgage backed securities - which keeps rates lower).
- Fed Funds Futures are now indicating the likelihood of a 1.0 cut to the Fed Funds rate as opposed to the previously expected .75. This is significant because the fixed income markets (which include US treasuries and Mortgage-Backed-Securities) had been showing signs of fear with respect to inflation. As the greater the inflation, the lower the return of a fixed income investment, the holders of those investments sell when inflation is a concern. As competition among sellers increases, the prices of the bonds become lower. Lower prices equal higher yields, and it is the yield of a Mortgage-Backed-Security that moves in direct proportion to mortgage rates.
Normally, we would see the MBS market react with fear to the prospect of an even higher than expected FED rate cut, especially after the previous weeks have been so fraught with inflation panic. But all that seems to be taking second chair as the market comes to terms with its recessionary slide. In other words, the weakness in the economy, the mitigation of Bear Stearns' catastrophic failure, and the FED's strong (and getting stronger) commitment to take the necessary steps to provide liquidity are more important than inflation concerns at the moment.
A weak economy generally lowers stocks and raises bond prices. If MBS prices go higher, that is good for mortgage rates. So we certainly have the economic weakness, but we have been held back by quality concerns. MBS quality has been in question on the heels of the subprime meltdown, home price depreciation, and a lack of liquidity (liquidity is more a partner of quality perception than a cause). But if it is the buyers or holders of MBS that are weak, this can be bad for mortgage rates as investors (here's that quality part) perceive that weakness as a risk to their investment, thus putting their money elsewhere, such as the US treasuries which have run up record high spreads versus MBS.
The recent developments, the mitigation of disaster if you will, are helping that relative "quality perception." Though that phrase is grossly ironic in this context, keep in mind that any quality perception in already "priced in" to the market. It is the improvements that change rates. So if investors think they might be a little less hurt in the MBS market today than they did yesterday, rates will improve. It's as simple as that.
Stay tuned for the rest of the action-packed week. Given the data and the market's response to it, this week is promising. But we've seen the potential for surprise recently so anything is possible in this market. My advice, as always, is to lock when you are happy with the rate. They are slow to come down, but very quick to go up.