Future Direction of Mortgage Rates.  The future level of 30-year fixed rate mortgages will entirely be driven by where MBS prices go. The MBS market is considered an “efficient” market, meaning that the current price of any MBS bond today is based upon all known information with respect to future economic conditions. If an investor is going to own a fixed rate bond for many years, knowing what the future inflation rates will be is critical information to know in order to determine the net return on investment from owning a long-term bond. The uncertainty as to which direction inflation rates will go in the next several years directly results in the price volatility of MBS bonds today.

Besides inflation, another powerful impact to the value of long-term bonds, will be how much the Federal budget deficit changes in the next several years. If the government spends more than they are receiving in tax revenues, this forces the U.S. Treasury to issue new amounts of Treasury bonds to finance the deficit. So, if the budget deficit grows by $1 trillion dollars, the Treasury must issue $1 trillion of additional Treasury bonds. As this huge increase in bond supply hits the markets, it would immediately push down bond prices through the normal economic concept of supply and demand. As bond prices go lower, this mathematically pushes up bond yields.

Bond Market Volatility.  The top focus of MBS investors today is trying to forecast inflation rates and the size of the Federal budget deficit over the next several years. As new information becomes available every day, the markets will view this new information through the lens of its potential impact to their previous forecasts and then the markets will make adjustments accordingly to the prices of bonds.

The markets expect tax rates will be lower under the “red sweep” scenario, meaning that Republicans have control of the White House, Senate, and House. Tax revenues received by the government will be driven by the tax rate and by the level of economic activity

If the economy can grow without pushing inflation rates higher, this will create incremental tax revenues that can be used to help reduce the Federal budget deficit. If the stock market goes up, as stocks are bought and sold this can generate substantial amounts of capital gains tax revenue to Federal and state governments.

Floating in Volatile Markets.  Floating in volatile markets, such as we have today is generally not the best strategy. The ability of a U.S. homebuyer to purchase a home with their interest rate fixed for 30-years but also allows them to refinance to a lower rate without any penalty is an incredibly powerful financial tool. It essentially provides a homeowner with a “heads you win, tails you win” outcome. If rates go higher, they thank their lucky stars that their LO or realtor told them to lock their rate. If rates go lower, they can refinance for free and lock in a new lower rate for the rest of their life. A prepayable 30-year fixed rate loan is not available anywhere else in the world, and this financial instrument is one of the keyways a homeowner can create wealth through homeownership. They are 100% protected from rising rates if they go higher, and they can 100% benefit from lower rates when they decline.

There is a catch in being able to benefit from this incredibly powerful financial instrument. It has no value if you sit on the sidelines as a renter, or if you are floating while you apply for a mortgage.

If in the next 12 months inflation rates increase and the Federal budget deficit increases, long term fixed rates could be much higher than they are today. 

Let’s take a hypothetical scenario where rates are 7.00% today, and MBS investors think that if inflation and the deficit both go down in the next 12 months, rates will drop to 5.00% which is the scenario everyone is hoping for. But if inflation and the deficit both go up, rates will go to 9.00%. In this hypothetical scenario, the borrower absolutely should lock at 7.00% and this will be the maximum rate they will ever pay on this home. If rates drop to 5.00%, they can then refinance. Today’s current market conditions are not far from the above hypothetical situation. If a borrower is floating, every day they are taking a 50/50 bet that tomorrow’s prices will be better or worse than today’s prices. The key point is if they wait and rates go up, they may not come back down for a long time. If they lock and rates drop, they can refinance six months later. If I was buying a house today, I would rather take the risk of paying a higher rate for six months compared to paying a higher rate for the next 30-years.

This Market Update and similar such communications are for informational purposes only and are based on publicly available information. These materials are general communications, which are not impartial, and are provided solely for discussion purposes, and not in connection with any product or service offering. The opinions and views expressed in this Market Update are as of the date of this communication and are subject to change. Any forward-looking views and statements contained in this Market Update are based on current estimates or expectations of future events or results. Actual results may differ materially from those described in this Market Update. The views expressed in this communication should not be attributed to Guild Mortgage Company as a whole and may not be reflected in the strategies and products offered by Guild Mortgage Company.