Market Update 6-5-21
A Look Into the Markets
"The day the music died" - "American Pie" by Don McLean
This past week, home loan rates ticked up slightly but remain near three-month lows. Despite historically low rates, mortgage applications ticked down for the second consecutive week as tight inventory and rapidly rising home prices weighed on purchase activity.
Opportunity Is Knocking
Mortgage and housing professionals should be telling their clients and sphere of influence that if they are looking to either refinance or purchase, the time is now.
Home loan rates are literally being pinned down by the Federal Reserve, which is purchasing $120B worth of Treasurys and mortgage bonds every month. If the Fed were not purchasing these bonds, home loan rates would be much higher.
How do we know? Look at real rates, or the value of the 10-year note yield after the effects of inflation. At the moment, the 10-year yield is near 1.60%, and inflation expectations for the next ten years are 2.45%. If you subtract the 2.45% from 1.60%, you get -.85%. So, we currently have negative real rates, meaning investors buying the 10-year note are losing -.85% a year. That is unsustainable over the long term. Who in their right mind would purchase the 10-year note as an investment just to lose money every year? Yes, the Fed.
The Federal Reserve has made it clear that they are not "even thinking about, thinking about" tapering their bond purchases.
What Happens When the Music Stops?
A look at history shows the last time the Fed was engaged in bond buying, or quantitative easing, was back in 2013, and this was the last time real rates were negative. In May 2013, the Fed simply stated that they could "taper" purchases in the future, and rates immediately shot up with the 10-year yield going from 1.60% to over 3.00% in just a few months. This caused a major spike in mortgage rates.
The Fed Conundrum
Despite heightened inflation fears and calls to taper bond purchases, the Fed continues to say, "Now is not the time." There may also be pressure from the Treasury Department to keep long-term rates low as the country embarks on an enormous stimulus and spending spree. It could be quite detrimental for long-term rates to tick up as our debt expense would be massive.
Over the next few months, watch inflation. If readings come in hotter on a month-over-month basis, we could see upward pressure on rates, like we did between January and March of this year.
And remember, the uptick in rates happened despite the Fed bond buying, which is a testament to their inability to keep long-term rates pinned down if inflation is a problem.
Bottom line: This is an amazing moment to take advantage of an interest rate environment that is being manipulated by the Fed. The Fed will continue to buy bonds and keep rates relatively low for quite a bit longer, but if inflation ticks up, we should expect rates to tick up too.
Speaking of inflation, on Thursday CPI is to be reported. Currently the annual rate of inflation is 4.2%, well north of mortgage rates for the first time in 50 years. This is unsustainable longer term. Either inflation must moderate, as the Fed expects, or rates must tick up, or a combination of both. The CPI reading last month caused a spike in rates; this one might as well.