How the stock market impacts mortgage rates

Although inflation expectations are the primary factor that influence the direction of mortgage rates on a day-to-day basis the stock market can also have an impact.

To understand how this relationship works it's first important to understand how mortgage rates are determined. Mortgage rates are entirely determined by the price of mortgage-backed bonds (MBS's). MBS's are bonds that are issued by Fannie Mae & Freddie Mac that are backed by the interest paid by mortgage holders. Like the stock market there is an exchange where MBS's are traded.

There is an inverse relationship between the price of MBS's and mortgage rates. When the price of MBS's increase mortgage rates drop and vice versa.

So, to understand how the stock market can influence mortgage rates we have to understand how they impact the price of bonds. Stocks and bonds compete for the same investment dollar. In other words, an investor with money to invest has to make a decision to invest their money in either the stock market or in the bond market (it should be noted that there are other investment options but these two classes are the primary vehicles for investment capital).

For an investor stocks are generally thought to provide higher returns over time but also come with greater volatility. Conversely, bonds tend to have lower returns over time but have less volatility. Because bonds tend to provide low volatility with modest returns the bond market can often act as a "safe-haven" for investors who sell their stock positions.

Therefore, in general, when the stock market goes down it is a sign that investors are selling stocks and shifting their capital into bonds. This boosts bond prices and drives mortgage rates down. Conversely, when the stock market rallies it is a sign that investors are selling bond positions in order to shift capital into the stock market. The greater supply of bonds on the market drives prices lower and pushes mortgage rates higher.

It's important to understand that there are a myriad of factors that impact mortgage rates on a day-to-day basis. Inflation expectations & technical trading patterns are two of the primary factors that we monitor. However, in the absence of new information on these two topics it's not uncommon for mortgage rates to be impacted by the stock market in the aforementioned manner.

Rate Update May 8, 2008

Technical trading patterns are what helped mortgage rates move lower yesterday afternoon. In yesterday’s ‘rate update’ we stated:

“Mortgage-backed bond prices continue to trade just above important technical support. We are watching this level and hope that prices hold. If prices should slip we will shift our outlook to a locking stance.”

Not only did bond prices hold yesterday afternoon but thanks to weakness in the stock market they rallied which pushing mortgage rates lower. Below is a chart showing bond prices hitting the technical support level (shown in circle). The green bar to the right of the circle represents bond prices moving higher off this level. This is a good sign for mortgage rates and so we shift our outlook to floating.

Current Outlook: floating

Rate Update May 7, 2008

A report from the Labor Department showed worker productivity was better than expected in the first quarter. Furthermore, the report showed that labor costs increased less than economists had expected. Watch today’s you tube video to learn how productivity & labor costs can impact mortgage rates.

Despite the positive economic news mortgage rates have reacted to the stock market over the past couple days. When stocks have rallied mortgage rates have been pressured higher which is what we’d expect to see.
Mortgage-backed bond prices continue to trade just above important technical support. We are watching this level and hope that prices hold. If prices should slip we will shift our outlook to a locking stance.

Current Outlook: neutral with floating bias

Rate Update May 6, 2008

A disappointing earnings report out of Fannie Mae is pressuring stocks lower this morning. This weakness is helping to support mortgage-backed bonds prices right at an important technical layer of support. If bonds can rally off this support level it would be a welcome sign for mortgage rates.

Working against interest rates is the ever-increasing price of oil. The price for a barrel of oil has hit $120 and one Goldman Sachs analyst believes it could go as high as $150-$200 over the next 12 months. This would certainly have inflationary impacts on our economy that would likely cause rates to rise.

Current Outlook: neutral with floating bias

Rate Update May 5, 2008

Mortgage-backed bonds are coming under selling pressure this morning threatening the rate gains we made earlier on. Rates began the day .125% better than Friday morning’s rates thanks to weakness in the stock market stemming from the Yahoo/ Microsoft withdrawal.

However, mortgage-backed bonds are now beginning to sell-off as well likely in response to some inflationary imbedded in the monthly Institute for Supply Management (ISM) report.

We like the heavy technical trading support that is just below bond prices. If bond prices can hold we may see rates improve over the next couple weeks. However, if bond prices manage to break through this technical support rates will move higher before they get any better.

Current Outlook: neutral with floating bias

Rate Update May 2, 2008

Every once in a while we get it right and yesterday we certainly called the right play on the monthly jobs report strategy. Although the report showed a 25,000 job contraction in April it was still enough to beat analysts’ expectations which were calling for 75,000.

As a result mortgage rates have moved higher. The second half of our prediction was that mortgage rates over the next 2-3 weeks would rally back pushing rates back to or even lower than they were mid-week.

Current Outlook: locking in near-term, floating long-term

Rate Update May 1, 2008

As you’ve likely heard the Fed did cut short-term interest rates by .25% yesterday. If you read yesterday’s ‘rate update’ you knew this would happen. We also explained that there were two scenarios that might play out in their post-meeting statement. It turns out that one of the two scenarios did take place. Here is a summary:

*If the Fed stresses concern about inflation in their statement over economic recovery it is likely a sign that the Fed is done cutting rates in the near-term. Although concern over inflation is bad for mortgage rates because the Fed is indicating that that they’ll pause it could actually strengthen the US Dollar and help mortgage rates.

Essentially the Fed indicated that they are likely done cutting rates unless something drastic occurs.

Today the Personal Consumption Expenditure Price Index (PCE) was released and showed inflation in line with analyst’s expectations.

Tomorrow the monthly jobs report is due. As a reminder, analysts will be looking at the number of new jobs created in the economy. Typically, when this number beats expectations rates worsen and vice versa. Watch today’s you tube video for our advice on whether or not to lock……

Current Outlook: locking in near-term, floating long-term