Interest rates 2018 to present

Interest Rates Plunge – Is There a Bottom?



Let’s take a quick look at what’s happened over the last few weeks.

If you look at the chart below, you’ll see that the 10-year U.S. Treasury yield (red line) has plummeted just in the last week. It was on its way down anyway, but as the stock market began to crash money moved from stocks into this much-safer investment, driving bond yields down. While Treasury bonds are not directly related to mortgage rates, they compete for the same investment money as mortgage-backed securities, so they attract the same investors for the same reasons. Treasury bills can be tracked in real time, so they tend to be used as a benchmark for where mortgage rates are.

Today, however, we are clearly seeing when mortgage rates disengage from Treasury bond.

Interest rates 2018 to present
Interest rates are plummeting

The blue line is the Fannie Mae 60-day yield. When investors invest in mortgages, they do so by buying mortgage-backed securities. They are seeking a particular yield, which varies by the minute. Fannie Mae adds on its margin, and then offers to buy mortgage pool from lenders with the yield they require. You can see that the yield Fannie Mae demands follows the yield on Treasury bonds fairly closely, albeit somewhat slowly when yields decline, especially when they decline rapidly.

Nevertheless, it does move down, and Fannie Mae’s yield is now lower than it has ever been.

Have mortgage rates gone down?

To be sure, mortgage rates have dropped, but nowhere near as far as we would expect (or maybe hope.) Why is this? Two reasons:

First, when the market is highly volatile (and boy, is that the case right now) there is a lot of risk in following the yields down. If market yields suddenly jump up, lenders could be stuck holding pools of mortgages with yields that are too low to make a profit on. They might even lose money. To mitigate risk, lenders are always reluctant to follow interest rates down too quickly.

In a volatile market, mortgage rates tend to jump up, and settle down.

Second, refinance activity has soared. Lenders staffed up a little to prepare for this surge in activity, but no one believed it would be this dramatic. Lenders, therefore, have far more business than they can handle. Under those circumstances, why offer super low rates? It makes no sense to have a sale when you can’t handle all the customers in the shop.

Consequently, if you look at the green line in the chart above, you’ll notice that the interest rates folks actually locked at over the last week dropped, but only a fraction of what they would have if lenders had followed the market down.

Lender Margins at All-Time High

The chart below tracks the margin lenders are charging over their “wholesale” margin. This margin is now higher than it has ever been in history.

Lender margins are at an all-time high
Lender margins are at an all-time high

If the Treasury Bill yields stay down, mortgage-backed securities are sure to follow. If mortgage-backed securities stay down long enough, eventually lenders will follow it down, but when? Most likely we won’t see significant improvement in mortgage rates until 1) the market stabilizes and 2) lenders begin clearing out their pipeline.

Neither of these appears about to happen soon, and we are already right at the lowest mortgage rates in history.

My prediction is that rates will continue to settle down incrementally for the time being. We might see more improvement in the 10-year and 15-year mortgages than the longer-term offerings. If the stock market settles down and begins to recover, expect interest rates to jump up.

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