Sunday, November 14, 2010

Will Rates Go Lower?

Historic, low home loan rates have been about the only thing stable in the economy these days. This low level mark breeds complacency, especially with the buzz in the air that rates may go even lower. But the question hangs in the air like humidity on a southern summer day - will rates go lower? And if there is a chance, should you wait and see or move forward now?

More Quantitative Easing
The buzz that began earlier this fall stemmed from talk coming out of the Federal Reserve that they were considering another round of Quantitative Easing in an effort to stimulate the sluggish economy.

What is Quantitative Easing? Here is what Wikipedia says:

The termquantitative easing(QE) describes a form ofmonetary policy used by central banks to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

"Quantitative" refers to the fact that a specific quantity of money is being created; "easing" refers to reducing the pressure on banks.

During the first round of quantitative easing, implemented during the credit crisis, the Federal Reserve bought Mortgage Backed Securities (MBS) which helped drive home loan rates lower. Lower rates resulted from these purchases because of supply and demand. When there is more demand, prices move higher and yields (interest rates), which move inversely to prices, move lower.

The Federal Reserve announced their new bond-buying program at their monetary-policy meeting on November 3 and they will be purchasing $600 billion in Treasuries through June 2011. This second round has been dubbed by the media as QE2.

Here's the Difference
With the new program, the Federal Reserve will only be purchasing Treasuries. Both Treasuries and MBS are bonds and compete for the same investment dollar. There is a natural spread between Treasuries and MBS. If the yield of Treasuries goes down because the Federal Reserve is buying $4 billion to $5 billion in Treasuries per day, it would likely help MBS move down in yield (interest rates) and up in price as well to remain competitive. This natural spread is the reason many anticipate mortgage rates improving.

Another camp speculates that MBS may get disappointed by QE2, like a jealous suitor, and sell off. A sell off would mean price deterioration, resulting in higher yields (interest rates). An old-time trader's saying goes something like this, "Buy on the rumor and sell on the news." Since all this QE2 talk began, the bond market has (for the most part) had a small party. Could this be the "buy on the rumor" behavior? If so, then that would take us down the path of thinking that "sell on the news" will follow.

But How Low Can They Go?

Assuming the market responds favorably and MBS improve, it is probably unlikely that rates will move significantly lower than they are today. For lenders to be able to offer a mortgage rate around 3.625% to 3.75%, it would require significant trading by Wall Street investors in the 3.0% coupon. This coupon has seen very little activity.

In addition, lenders have been slammed with refinance volume and are running at, or over, capacity. Also, processes have slowed due to new government guidelines and lenders increased attention to compliance. With processes moving slower, lenders are requiring longer lock periods which impact interest rate pricing. They may look to further manage capacity by regulating their volume through the interest rate offered.

"Wait and See" is full of risk. If MBS improve, and if lenders pass on the price improvements to the borrower, it is highly likely the benefit in interest rate will be incremental. That's a lot of "if's" to hold onto for a hope of small gains.

The downside risk is far greater than the upside potential for rates to improve. If QE2 is not well received, the bond market would sell off and mortgage rates would suffer. History shows us this can happen much more quickly than any improvement.

With these incredibly low interest rates, there may not have ever been, nor ever be again, a better time in our history to purchase or refinance your home. The waiting game could be risky and the opportunity may disappear.

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