For the last few months rates have been rising across the board. At this point, it’s not really news. Mortgage rates, treasury rates, credit card rates, car loans. Does not matter the financial instrument. Rates are rising due to inflation. We know this. But over the last couple of weeks some real confusion has crept into the market and things appear to be getting out of hand. In the last week alone, mortgage rates have moved from 6% to 7% without stopping anywhere in between. So the question at hand is…when do things “calm down”? We seem to have moved from a normal increase in rates to a freak out situation. So what’s going on?
The current situation feels a bit familiar. Interest rate markets have seized up and it’s both mortgage and trader driven. First the mortgage side of things. Let’s remember that the market for mortgages is massive and usually very liquid. So if you want to invest in mortgages you can do this at 5.5% to about 6.75% over the last few weeks without much issue. But as rates have been rising, two issues popped up. First is the issue that with rates moving so quickly, most investors don’t want to buy high coupon rates because they think rates will drop quickly soon and those loans will refinance to lower rates. So they won’t pay the usual price for rates on the higher end. This has led to many consumers being charged points or upfront expense to get a rate that is already high. The secondary consideration, which has come into play over the last week since the most recent Fed meeting is that nobody knows where this is going to stop.
This secondary reason is the bigger problem. Similarly, during the first stages of the pandemic, we thought for a week that rates would be dropping like a stone, and they did. But then, in a quick about face, the mortgage bond traders became unsure if things would turn around quickly or if there would even be a mortgage bond market. So they stopped buying. This caused rates to rise from 3.75 to 5% in a couple of days. Once things settled a bit, buyers came back to the market after the Fed injected liquidity (cash) into the market to keep things moving. Now, we seem to have a similar buyers strike. No traders want to buy mortgage bonds at 6 so they go to 6.5%. Nobody buys, so they go to 7%. If nobody buys they go higher still. Traders hate uncertainty.
Right now, it feels like they are waiting for some guidance from the Fed. However, there is real risk that the Fed does not want to offer any and let the market figure it out for itself. It’s been two decades since the market has had to guess at the Fed’s intentions and they are rightly concerned that they cannot measure the risk in the market. So they don’t buy. Bond traders don’t lose any money if you don’t invest at all.
That cannot go on forever though. What likely happens is that rates/bonds eventually ‘catch a bid”. At some point, either rates go high enough to make large investors see some value or the Fed steps in and gives some guidance and/or liquidity. Either way, at that point, we should see some moderation from the craziness of the rate jump of the last week or two. But that could take more time and pain. I always say, if I knew exactly when this would happen, I’d be a retired bond trader. So take my opinion as a concept and not trading advice of any sort.
Either way, rates aren’t going back to 2.75% soon. But I think the market will settle a bit in the next few weeks.
