A better economy usually means higher rates

Remember, this is a blog—oversimplification will prevail.

Lesson #1:  Rates are driven by the mortgage-backed securities (MBS) market.  MBSs are more similar to bonds than stocks.  Money managers who have to produce returns for their clients invest in stocks (more risky but higher returns) and bonds (less risky but lower returns).  When money managers think companies will produce higher stock returns, they invest in stocks. When the economy shows signs of improvement, company stock prices tend to rise.  So, said another way, when the economy shows signs of improvement, that generally means stock prices will rise, which will cause money to flow to stocks and not bonds (or MBSs).

Lesson #2:  When bond prices decrease, mortgage interest rates worsen.  A bond’s price and its yield are inversely related. That means that when the bond price goes down, the yield goes up (and vice-versa).  Mortgage interest rates track with the yield.  So, as bond prices go down, the yield goes up, mortgage interest rates go up.  The price of a bond will go down when there’s less demand for it.  If money flows to stocks, that means it moves away from bonds.  As bonds are in lower demand, the price will drop, and the yield will increase.  Remember, mortgage interest rates track to the yield.  To review: the less demand for bonds (or MBSs), the lower the price, the higher the yield, the higher mortgage interest rates will go.

The Million Dollar Question: Will the economy improve that much this year?  This is where my crystal ball gets fuzzy.  I think the nightmare of the financial crisis of 2008 is over.  We’re stabilizing.  High unemployment is a problem, and I see it getting slightly better.  I’m a believer that the consumer tends to drive the economy and if they have money to spend, the economy picks up.  I’m a believer that until we start to support the small business person, who employs most of the people in this country, unemployment will remain stagnant and the recovery will be sluggish.  The Fed’s quantitative easing (QE2) and the financial stability of the European countries are the wildcards here.  Given all that, I’m predicting that the economy has a good year and rates will increase a bit to 5.5% on the 30-year.

And by the way, let me put this back into perspective for you.  5.5% is still historically pretty doggone good.  So, if you’ve been “left out” of this past year’s refinance opportunities, this will still be a great year to get it done.  Give us a call.