7/22/2017 | Casey Fleming | Like a butterfly, interest rates fluttered around this week without actually really going anywhere, and looking forward still appear to be looking for direction.
There is good news in this. As I have said before, interest rate markets love certainty, and even though the last month has brought a very uncertain certainty, the fact that movements in the market have been very small tend to give investors confidence that rates will stay low for a while. That belief allows them to pull some money out of stocks and move them to bond investments, slowly driving down interest rates.
Another way to say this is to say that slow, soft movements in rates tend to be more sustainable.
Looking at the chart below, you’ll notice that the 10-Year U.S. Treasury yield (red line) has been slowly settling back down toward their 2017 lows that we hit back in early-to-mid-June. The Fannie Mae 60-day yield (Blue line – essentially the wholesale cost of mortgage money to lenders) has been tentatively following the Treasuries down.
The green line is the Freddie Mac Weekly Mortgage Market Survey, which tracks interest rates that people actually locked loans at the previous week. (The report comes out Thursday morning, so a week runs Thursday through Wednesday.) As predicted, people got lower rates last week than the week before, and at this point we can predict this index will drop slightly again when it is reported next week. (Although next week could bring volatility, so you never know.)
Will lender margins compress?
The yield investors decide they need to earn for long-term fixed investments (bonds) drives the wholesale cost of mortgage funds, as you can see from the above chart. The wholesale cost of mortgage money in turn drives the interest rates that home owners have to pay, but it’s not the only factor. The lenders charge a margin which moves over time based on a number of factors, one of which is keeping their pipelines full to as to operate at as close to full capacity as possible.
So, competition forces lenders to lower their margins when volume goes down in order to keep their pipelines full. It’s therefore interesting to look at mortgage origination volume trends. As you know if you’ve been reading this column for a long time, margins jumped up in 2016 partly due to new regulations which increased the cost of underwriting and processing a mortgage, and partly due to the fact that it was a much busier year than lenders had anticipated, so their pipelines were very full.
With the rise in interest rates after the election it was certain that mortgage origination volume would decline. The first quarter originations (as measured by total loan amounts, not units) fell 23% from the 4th quarter of 2016 by dollar value, although it was up slightly from the same quarter one year earlier. In unit volume, however (which is more important from the perspective of keeping pipelines operating at capacity) volume fell 30% from the 4th quarter of 2016, and 21% from a year ago.
While it is too early to get mortgage national volume statistics for the 2nd quarter of 2016, large banks (which originate nearly half of all loans in the U.S.) have started to report their quarterly results. Citibank reported a drop of 18% in original volume from the first quarter to the second, Wells Fargo saw a loss of 19% year-over-year, and Chase saw a drop of nearly 26%.
We would expect with declining volume that margins would drop this year, and we can see by the chart above that there has been a more-or-less steady downward trend in margins this year. When wholesale rates were very low in late May through late June the lenders did not follow them all the way down, so margins rose slightly. But the low origination volume in the 2nd quarter has taken its toll, and margins do appear now to be headed solidly down.
Economic News and Mortgage Rates
As I noted in last weekend’s post, the week of July 17th would be a slow one for economic reports, which at least partially accounts for the small movement last week.
On Monday the Empire State Index was down significantly, but still showing some economic growth.
On Tuesday the Home Builders index showed a slight decline, pointing to a possible slowdown in the building industry in the next few months.
Wednesday, however, brought a surprisingly high number of Housing Starts (1.215 mm compared to 1.163 mm expected) and Building Permits issued in June hit 1.254 mm compared to 1.168 mm in May. These reports shook the bond market a little and held yields up Wednesday afternoon.
On Thursday Weekly Jobless Claims came in at a very low 233,000, compared to 248,000 the week prior, and an expected 245,000. Leading Economic Indicators showed surprising strength in June with a 0.6%increase, compared to 0.2% in May.
The good news is that while interest rates should have moved up on these reports, they held fairly steady instead. Retail mortgage rates rose very slightly on Wednesday afternoon and Thursday morning, but that appears to be reversing now.
Week of the butterfly – July 24th
Fun fact: The word “butterfly” stems from the middle English “flutterby.” Why am I using this as a metaphor this week? Because like a butterfly, interest rates last week fluttered around a lot looking like they wanted to go somewhere, but in the end ended up in about the same place, and it’s hard to tell where they’ll head next. But we can bet it won’t be a straight line.
This is going to be a busy week, with lots of risks in the reports, so wherever interest rates go, retail mortgage rates are not likely to come down much, if at all, and are more likely to jump up at the first sign of trouble.
The most notable economic report due Monday, July 24th is the Existing Home Sales report for June. A consensus of economists forecasts the number to be 5.58 mm homes, down from 5.62 mm in June. The forecast seems low to me, although June is traditionally a little slow as families deal with graduation and summer vacations. Nonetheless, watch this report closely. A number on the high side could send bond prices lower, and yields higher.
Tuesday we have May’s Case-Shiller Home Price Index, a report that is always interesting but rarely important to interest rate markets. The Consumer Confidence Index for July is a potential market-mover, however. Consumer confidence appears to have been waning; if that trend continues it will be good for bonds, but mortgage rates are unlikely to follow bond yields down on Tuesday, because…
On Tuesday and Wednesday the FOMC (Federal Open Market Committee) meets to discuss general economic conditions and to decide if / when to raise short-term rates again, and when to begin tapering their Treasury Bond and Mortgage-Backed-Securities investments. Their announcement Wednesday afternoon will be closely watched, and could absolutely be a market-mover. If the announcement is generally steady – meaning that they plan to hold the course they’ve established for the year – expect bond investors and mortgage lenders to breathe a collective sigh of relief and rates could drop a bit.
Wednesday also brings New Home Sales, but this report will be overshadowed by the FOMC announcement.
On Thursday we learn about weekly jobless claims, of course, and Durable Goods Orders for June. Both of these could be market movers if they are surprising. With a generally tight labor market and weekly jobless claims running lower the last few weeks than anticipated, another low number could spark fears of inflation and move interest rates up. Durable goods orders are expected to show a strong increase from May, so a strong report will not upset the markets, but a weak report could be good for rates.
Friday brings us the Gross Domestic Product report for the second quarter, a closely-watched index, and the Employment Cost Index for the second quarter and the University of Michigan Consumer Sentiment report for July. The consensus shows that economists expect these reports to show a moderately expanding economy, moderate increases in wages. and somewhat upbeat consumers. Surprises in any of these reports have the potential to move interest rates.
A busy week for economic reports
Because bond investors tend to be a nervous bunch, interest rates tend to jump up and settle down. Quiet weeks are generally good for interest rates, as barring unexpected news rates have a chance to settle down. Busy weeks can drive interest rates to more dramatic movements, but since rates tend to jump up and settle down, this coming week there is more risk of a jump up in rates than there is chance of further improvement.
Rates will float like a butterfly, and if they gain traction in any direction, will sting like a bee. Stay tuned!
This article represents the opinions of Casey Fleming, and not necessarily those of C2 Financial Corp. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial Corp., have any magical insider information about bond markets, real estate 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 Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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