Wednesday Could Be Huge For Interest Rates

Casey Fleming

Last weekend I wrote:

“This coming week is a quiet one for economic reports, although you never know when some unexpected news might pop up and move the market. But if bond yields drop next week retail rates are unlikely to follow, so rates would stay about where they are. If bond yields stabilize, the current margin is unlikely to compress, so rates stay about where they are. If bond yields rise rates are likely to jump in reaction.”

As it turned out, the only market-moving news was that the European Central Bank on Thursday decided to reduce their overnight rates slightly, and step up their quantitative easing program. Markets went nuts for an hour or so and then settled down to about where they were before the announcement.  So, at the end of the day there was no huge movement last week.

Stocks and interest rates generally move in the same direction.  This week proved no exception as bond yields rose slightly in alignment with stock prices struggling upward.

Bond yields rose this week. Mortgage-backed security yields followed. Interest rates rose slightly in response.
Bond yields rose this week. Mortgage-backed security yields followed. Interest rates rose slightly in response.

You can see from the red line above that the 10-year treasury yield continued to rise, and from the blue line that mortgage-backed securities tracked the rise in yields very closely.  Freddie Mac reported that the average conforming loan rate locked in last week rose slightly as you can see with the green line, so retail rates did indeed follow investor yield upward.

The gross profit margin lenders earn went down slightly this week, but is still fairly high.
The gross profit margin lenders earn went down slightly this week, but is still fairly high.

In this next chart you can see that the lender’s gross profit margin – the interest rate spread between the rate offered by the agencies and the rate offered to you – stayed at about the 0.3% range.  (The blue line)

I changed the red line to be a trailing 30-day moving average in order to show how patterns develop over time.  As I pointed out last week the average yield spread has risen considerably since the beginning of this year.  This week the spread dropped below the current trend, but as volatile as the market is we will see if it stays there.  Reports indicate that mortgage applications are down, so lenders’ pipelines are probably emptying out and if they do, the margin is bound to come down as lenders lower pricing try to bring more business in.

Unlike last week, this coming week we have a lot happening on the economic news front.  The reports that are most likely to move markets are:

Tuesday’s retail sales and producer price index reports are expected to show stability, and will probably not move markets.  The Empire State Index, however, might show regional contraction that could make investors nervous enough to stall out the current stock market rally.  If so, bonds could rally and bond yields could drop.  Investors also may shrug this off as weather-related and it could be no big deal.

On Wednesday the consumer price index is expected to be stable and should not alarm anyone, but it is always closely watched.  Housing reports are not very likely to move markets, but industrial production and capacity utilization could, if either one shows significant improvement.  If so, pressure could be rising pushing wages up, and bond yields would have to react and move up too.

The big kahuna, however, happens Wednesday.  At 2:00 pm EDT the Federal Open Market Committee (The Feds) will release their policy statement and any changes coming from the meeting during the day, and at 2:30 Janet Yellen will conduct a press conference to discuss the announcement.  Virtually all analysts agree the Feds are unlikely to raise short-term rates, and unlikely to commit to a future date where they would be raised.  However, they may issue guidance in the announcement that could move markets dramatically.  It is not expected, however.

Lenders will be pretty much holding their breath until Wednesday afternoon, therefore, and margins (interest rate spreads) are very unlikely to come down below their current levels before then.

On Thursday jobless claims are expected to be tame, and could spur a rally in bonds (putting downward pressure on interest rates) if they come in significantly higher than expected.

Friday’s consumer sentiment report is also a potential game-changer, albeit with smaller potential.  Consumers have been getting less optimistic as of late, and that trend is expected to continue.

After nearly a month of climbing bond yields it seems like it may be time for investors to start picking bonds up again.  In fact, I would be surprised if that didn’t happen in advance of the FOMC announcement as a hedging move.  It is true that yields are still quite low – they are just barely higher than their low point for the entire year last year.  But a small correction in direction seems overdue.  However, activity should be limited until Ms. Yellen speaks Wednesday afternoon.

Look for bond yields (the red line in the top chart) to be stable or improve slightly Monday through Wednesday, mortgage-backed securities (the blue line) to track them, and the margin between mortgage-backed securities and retail rates (the blue line on the second chart) to rise a little until Thursday.  All of that portends a stable retail interest rate environment until Wednesday afternoon at least.

For Thursday and Friday, it’s really up to the Feds.  If they indicate they feel economic growth remains moderate but sustainable and inflation is contained, Thursday and Friday could see a nice little rally in bonds regardless of stock market direction, and if lenders decide a narrower margin makes sense, interest rates will follow down.  Once again, I foresee a week with little risk of huge movement in either direction.

As always, your mileage may vary.  If I actually knew what I was talking about I would be a billionaire.  (I’m not, if you were wondering.)

Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, C2 FINANCIAL CORPORATION
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This article represents the opinion of Casey Fleming, and not necessarily that of C2 Financial. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial, have any magical insider information about bond markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor C2 Financial are responsible for decisions that you make regarding your own choices about your mortgage or those of your clients.

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