Why Aren’t Mortgage Rates Even Lower than they are?

The fact that the Fed lowered rates a few weeks had little effect on mortgage rates is hard for many of us to understand. It is yet another example of media misinformation that good brokers work to correct, and help their borrowers understand.

The Fed sets a target (the Fed Funds rate) and attempts to control the rate which banks charge other banks to borrow money for 24 hours. This has near-zero effect on the 10-year Treasury or mortgage rates. The same economic conditions, however, impact short term and long-term rates, as well as the stock market. For example, the unemployment data that came out Friday had no impact on rates, as investors are fixed on the impact of the coronavirus. Many expect the Fed to reduce rates again in less than two weeks.

 With the 10-year Treasury, which is usually a harbinger of mortgage rates, why aren’t mortgage rates much lower than they are? With rates continuing to fall, the people holding mortgages as investments (mortgage-backed securities) were concerned about early pay offs. In addition, there are capacity issues. Many lenders have increased margins to slow volume.

As rates have fallen, many borrowers with fixed-rate mortgages refinance to lock in lower payments. The owners of the mortgage backed securities and mortgages (including banks, insurance companies, and pension funds), lose out on higher payment streams. Because of this, the prices of mortgage bonds tend to rise less in any given bond rally than Treasury securities, or other bonds, making them negatively convex. The process of hedging this event is complex, and results in banks and other investors purchasing Treasury securities, further pushing up their prices and pushing down their yields.

My Opinion: Once the 60-90 day outlook of things “returning to normal” levels out, expect the markets to rally causing short term slight rate increase to be followed by a sizable decrease as Lenders reduce the protection margin they have in place. We could see rates dip into the 2’s this summer if these conditions all come together.