Below is some good information from a secondary marketing director at a mortgage company. It may be a bit lengthy, so grab a cup of coffee or tea before you start reading, it is a very good summary of what has been going on with mortgage rates increasing in recent weeks.
As you’ve been well aware, rates have risen significantly since May 1st. The downward spiral really started with the jobs report on May 3rd. During mid-late April rates were improving and the markets (from a technical perspective) setting themselves up for a potential leg down. Much of this was in anticipation of a lousy employment report in May. We got the opposite. Not only was the jobs report positive, the previous one was revised basically telling the markets it was wrong. This instantly created a sell off. It then further spiraled downwards after comments from the Fed a few weeks back regarding prospects that they would start to curtail MBS purchases based on improvements in the overall economy. Then last week Wed. Bernanke reinforced this by further commenting that the Fed COULD (note that COULD is the key word here) start to taper their purchasing before Labor Day. This really destroyed support levels and mortgage bonds plunged into a free fall.
We’ve seen pricing deteriorate by approximately 400-500bps since the beginning of May. Lower coupons took the brunt of the hits as the market seemed to have come to the realization that the Fed’s stimulus will be ending, rates moving higher is just an inevitable event, and there is really no reason on the table any longer for rates to move lower. In early May, we saw FNMA 3’s trading at 105 and that same coupon is under par right now.
A few things worth noting. First, the Fed has not changed anything (yet). They are still buying MBS to the tune of $40 billion per month, and have said that they will continue until they see real and sustainable improvements in the labor market. The job market is still weak overall and the unemployment rate is still well above its long term normal levels. The Fed simply came out and said what we really knew was going to be happening at some point in time: When the labor markets improve, we will start to reduce the MBS purchasing. The market took these comments and over-reacted to it.
Currently the MBS market is extremely oversold and irrational things are happening. Investors are very quick to worsen pricing, and very slow to improve it. This is one of those times where having the ability to sell direct to FNMA and FHLMC can really help us relative to our competition. FNMA and FHLMC don’t factor their opinions of the future into their pricing decisions. They don’t have capacity issues, they don’t have pull through issues and they don’t have budgets and forecasts to meet in terms of production. All of these things factor into the pricing decisions that our investors make. What you get with a FNMA and FHLMC price is a raw MBS cash price with the addition of lenders servicing value placed on top of it.
If you start to notice over the next week or weeks that agency pricing is through (or better than) our investor pricing, it’s because the investors are taking a defensive position. I would expect to see this through month end for sure. The fact that we have agency direct executions allows us to be immune to those decisions our investors make with respect to pricing. This is the same dynamic we saw when pricing was falling last Sept/Oct and pricing kept getting stronger and stronger. Our agency pricing started to really outperform the investors by wide margins. This was because the investors were very slow to pass through gains. That happens almost every time we see market rallies. And when the market sells off, we see investors generally becoming defensive. Just something interesting to pay attention to over the next few weeks if this pricing holds. It should help from a competitive standpoint. I’d also anticipate FHLMC getting a lot more competitive when you compare investors in loan sifter.
Second – we’ve seen large price deterioration in a very short period of time. The concern here is pipeline risk. The potential exists for loans to expire that we may not be able to relock at current market because those rates are no longer available. And if they are, we could be looking at a 400-500bps loss to honor the lock. It’s critical that you pay very close attention to your pipelines to make sure you don’t let loans expire. Corporate will be forecasting an insane June due to the market movement and the necessity to get loans closed before expiration dates. The best thing you can do in this environment is assume there is no such thing a rush, UW will be taking 1-2 days longer, and the closing department will shut refis off the last week of the month. I’m not saying that this will be the case but if you assume this you should be much better prepared to get through the month than if you leave things to the last minute. Also appraisal turn times are increasing so they’re in the process of adding additional appraisers in certain markets but prepare a bit for longer turn times there also.
Lastly – the Fed, the government, and the housing experts in Washington are concerned about this rapid rise in rates and what it will mean for purchase applications. We are in a very fragile time in the housing recovery. A sharp rise in rates drastically affects affordability, which affects housing, which affects the economy and recovery. No one wants to see the recovery slow down and housing take a step backwards. At the same time rates rising is inevitable. We could see a few different scenarios play out in the next few weeks. There is a possibility that the market overreacted, bonds are oversold, and we see a slight correction. In this scenario (best case) we get back 25-50% of the losses we’ve sustained. We’re not going back to where we were on May 1st. The market clearly understands that the exit is coming and Fed will be stepping out of the way.
Another scenario is that the market has now priced itself where it believes it should be in a post Fed purchasing environment. In this scenario we may see a bit more price deterioration over the next month until we get to a sustainable trading range. We’ll see continued volatility until the market settles down and gets into this range, which will be very frustrating and expensive.
A more unlikely scenario is that rates continue to rise in a meaningful way from where we are right now. There is too much risk to the housing recovery for the Fed to sit by and let this happen. If the markets continue to react the way they have in the past few weeks without any surprise economic data, the Fed will most likely intervene with some commentary to settle the markets down. This scenario also would have to assume that from here, part of the reason rates would rise would be economic related. Ex: inflation is present, GDP is expanding faster than anticipated, factories are hiring, consumers are optimistic about the economy, etc… None of this is really present in a meaningful way yet.
The bottom line is how in the heck do you explain this massive change in rates to your customers? I’ve gotten a number of emails in the last day or two on this topic and I’m by no means an expert. But here is what I would say if a customer asked me why rates have changed so rapidly, so fast:
“First of all the reason interest rates have been arguably 1-2% lower than they really should be right now (and have been over the last few years) is that the Federal Reserve stepped in during the meltdown and started buying Mortgage Bonds. This artificial demand created a situation that helped keep rates down while the economy was trying to get to a recovery. Without the Fed intervening, rates would have been much higher and people would not have been as eager to purchase a new home. Also millions of people would not have been able to refinance their loans, freeing up cash flow that ultimately can circle back into the economy. That’s why the Fed stepped in – they had to find ways to lower interest rates to help the economy recover. The Fed can’t do this forever and they have been saying all along as soon as they see the housing market on solid ground and economic conditions start improving, they need to back off. That’s basically what happened over the last few weeks. The Fed has been telling us they see the end of the road in terms of their purchasing of Mortgage Bonds. Home prices are increasing in many markets around the country, we’re seeing new home purchase applications continue to be very strong. Credit has loosened a bit since the crisis and we’re closing record amounts of loans for new home purchases. It’s hard to argue we’re not in a recovery right now from where we sit being a mortgage lender. And historically if you look at housing affordability, even with the recent increase in rates, we’re near historic levels. 4%-4.5% for a 30 year fixed rate loan is still an amazingly low interest rate.
The market right now is adjusting itself accordingly and pricing mortgage bonds where they should be without any Fed intervention. It’s unlikely that we’ll see rates get back to the levels they were at earlier this year, and it’s also unlikely they’ll increase significantly from here. I would be very cautious in the next few weeks as the market is still very volatile. For rates to go back down we’d need a reason – like unemployment rates are actually getting worse, consumers are not buying new homes or spending money out in the economy. That’s not happening -we’re seeing the opposite so I would anticipate rates really are not going back down.”
Generally when there is this much money flowing out of bonds, you’d see a corresponding increase to some degree in the equity markets. We’re not seeing that. Equity markets have improved, but not as we would expect if this were all economic data driven shifts. This is a response to the perception that the Fed is stepping out and the market’s trying to figure out where it needs to be right now to properly compensate for risk, etc…
There are also changes expected to the G-Fee in the next 6 months. FHFA has said they plan on increasing the G-Fee by about 20bps between now and year end, which most likely will come in 2 installments. This will have an overall impact on conventional conforming pricing by about 80-100bps worse in price, on top of what we’ve already seen.
This will be important to watch for a few reasons but I would not be surprised if FHFA held off or changed their plans on that based on the run-up in rates. The reason they wanted to increase G-Fees was to promote private capital in the secondary mortgage markets. Now that rates basically just rose almost .75-.87% in a month, that same argument really doesn’t work. It would be a bit concerning to me if rates settle in this range and we still get the increases FHFA is talking about. Just something to be aware of that could be potential conversation for people that are sitting on the fence, etc… We could see an overnight event in the next 30-90 days driven by FHFA that creates a 40-50bps price deterioration.
Information courtesy of PMC.