Investors Lose Their Appetite: How Mortgage Rates Benefited

Positive economic news is known to bring negative bond prices. Bond prices will fall and yields will rise on positive news. But this go-around it appears the GDP news was…

By, Brian Barker, exclusive to Corridor News

The headline news appears bullish enough: Gross Domestic Product (GDP) was revised 40-basis-points higher to 2.9% for the fourth quarter. Most of what you would want up – consumer spending on durables and nondurables, nonresidential investment, and residential investment – was up.

The latest GDP data set the stage for a solid start to 2018. Perhaps the strong end to 2017 is the reason the Federal Reserve increased its GDP growth rate to 2.7% from 2.5% for 2018.

Positive economic news is known to bring negative bond prices. Bond prices will fall and yields will rise on positive news. But this go-around it appears the GDP news was insufficiently positive. Bond prices have trended higher; bond yields have trended lower. Yields trended mostly lower over the past week. The unexpected uplift in GDP growth did little to reverse the trend.

Determining if correlation is causation is easier said than done, but we’ll give it a shot. The bullish news on GDP growth could have easily been overridden by lingering trade-war worries. The worries have manifest in increased stock-market volatility. Five-hundred-point price swings in the Dow Jones Industrial Average haven’t been that unusual in March. The VIX, a measure of stock-market volatility, has trended higher over the past three weeks.

In short, many investors appear to have lost their risk appetite. When they lose their risk appetite, they frequently retire to haven investments, like U.S. Treasury securities. The haven investment that most interests us – the 10-year U.S. Treasury note – has seen its yield drop 13 basis points since March 21. The yield gets bid down because the note’s price is bid up by investor demand.

As the yield on the 10-year note goes, so go the rates on long-dated mortgages. They don’t necessarily go in the same proportion, though.

As a percentage, the 10-year note has seen a bigger decline than quotes on 30- year fixed-rate mortgages. That said, quotes on the prime conventional variety are at a two-week low at the national level, according to Mortgage News Daily. The range of 4.5%-to-4.625% still holds, but it holds closer to 4.5% these days.

With the Fed in a rising-rate mood, we don’t expect mortgage-rate quotes to drift lower. Then again, we don’t expect rates to drift higher either. A 4.5% quote on a conventional loan could easily hold for the immediate future. Trade war worries are unlikely to abate soon.

Investors also have a new worry that could hold rates in check: A continually flattening yield curve. The spread between the two-year U.S. Treasury note and our benchmark 10-year U.S. Treasury note has tightened to 48 basis points. This is as tight as it has been since October 2007.

Why does this matter? A flattening yield curve has often been a precursor to a recession and a stock-market selloff. When the yield curve flattens and then inverts (short-term yields are higher than long-term yields) we get a legitimate worry. An inverted yield curve has predicted all nine U.S. recessions since 1955, with a lag of six to 24 months, according to Bloomberg data.

The yield curve is still far from inverting. But given the flattening trend, the yield curve is worth heeding.

Still No End in Sight

Like the Energizer bunny, housing keeps going and going, as it has for the past six years. Given recent trends and overall activity, we see no reason housing won’t keep going in 2018.

Housing sales have been mostly positive to start the year. To be sure, existing- home sales struggle to move ahead in earthshaking steps, but they have moved ahead. Based on the positive trends in purchase-mortgage applications and the Pending Home Sales Index, sales should continue to move.

Single-family homes – both existing and new – continue to gain favor, particularly with the younger generations. (We highlighted Generation Z last week. This youngest of the adult generations has entered the single-family market with impressive zeal.)

The housing market isn’t perfect, by any means: Existing home activity remains crimped by low supply and rising prices. New home activity is being crimped by rising lumber, employee, and land costs. The good news is that rising buyer interest mitigates many of these ills.

There is always something to worry about, but housing has less to worry about than most segments of the economy. The segment with the least worries is the segment that frequently leads the market.

Brian Barker,
Corridor News Contributor
BBVA Compass