We’re in a very interesting place as far as interest rates go. They seem to be pretty much stuck in neutral regardless of what the market does.
Looking at the graph above you can see that U.S. Treasury yields (red line) are close to a 13-month low, and seem poised to stay there. Mortgage-backed securities (MBSs) have followed suit as you can see by the Fannie-Mae 60-day yield (blue line.) We hit a multi-year low on January 16th and February 2nd of 2015, but bounced off those lows before retail interest rates (the rates you actually pay – green line) could catch up with them.
Yields bottomed out again this year hitting a similar low on February 11th. Notice, however, that in the current downturn in rates the Treasury yields and MBS yields did NOT pop back up as hard and fast as they did in 2015. It seems investors in Treasuries and MBSs may be getting more comfortable with lower yields on long-term investments.
So, unlike last year when retail rates popped up dramatically in response to the yield jumping up, this year’s very small bounce in the yield produced no bounce at all in retail rates. Rates actually improved last week, albeit very slightly.
I have written often about the spread between the Fannie Mae 60-day yield (basically what investors are demanding, plus Fannie Mae’s cut) and the retail rates you are offered. Over time it tends to revolve around a roughly similar yield spread, but it does move up and down a bit.
Why is this? Retail lenders are quoting you interest rates for loans they will be delivering to investors two or more months from now. If interest rates are much higher at that time the value of your loan will be much lower. (For more on this read an earlier article What is Your Mortgage Worth?) The point is when retail lenders quote you a price they have to look at not only where rates are today, but also where they will be in two or three months, and quote your interest rate based on that projection.
So, as I’ve written many times, retail rates don’t follow wholesale costs down immediately, but do so over time if wholesale costs stay stable. Interest rates tend to jump up, and settle down.
Let’s look at this graphically. This next chart tracks the yield spread between mortgage-backed securities and retail rates over time. If you drew a trend line through this you would see that the “normal” spread is probably somewhere between 0.365% and 0.400%. In times of uncertainty (high market volatility) you’ll notice the spread increasing, and in time of stability competition slowly drives the yield spread back down. But over time lenders have to make money, so it never goes below a certain low.
The upward spikes represent days when lenders were unreasonably cautious and demanded a high yield spread if you wanted to lock your loan. The severe dips when lenders were unreasonably optimistic. Those who locked their loans on those days are very happy campers. You will notice that the yield spread always moved immediately off of the extremes.
But you also may notice that since the beginning of the year the yield spread has been consistently higher. In the last three posts about interest rates I pointed out the high yield spread and noted that this never lasted long, so rates were bound to drop if the MBS yield stayed low. Rates have dropped, but not as much as you would think. In theory, competition should have driven the yield spread lower.
It’s possible that increased costs associated with the new TRID disclosure rules (which went into effect on October 3rd, 2015) have increased lenders’ compliance cost so much that the spread will stay higher. Frankly, in my experience anytime a major change happens in the way we process loans there is much pulling of hair and gnashing of teeth and then we acclimate to the new rules and get back to business. Processing under the new rules isn’t that much harder (or shouldn’t be) and most lenders have increased their processing and administrative / underwriting fees; that should be enough to take care of any additional cost.
The bottom line is we can conclude only one of two things: either lenders expect the market to remain so volatile that low margins (yield spreads) are too great a risk, or that competition just isn’t doing its job at the moment. Since the latter cannot remain true for very long (there are a LOT of lenders out there) then the former must be true. Lenders are so nervous about the high market volatility that even competition for your business hasn’t been enough to bring the margins back down where they belong so far this year.
In the meantime, we can surmise they are not unhappy about the excess profit.
The implication is that either rates MUST came down soon if the yield on mortgage-backed securities remains stable, or yields on mortgage-backed securities must rise soon. Either way, the current yield spread cannot last indefinitely.
We shall see.