Why are mortgage rates rising when market interest rates are plunging? | Notes from Jim Haughey

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Notes from Jim Haughey
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Why are mortgage rates rising when market interest rates are plunging?

Jim Haughey

RCD Chief Economist

Mar 03, 2008

This divergence can not last long but it is consistent with the current unusual economic and financial environment. The plunge in short rates results from the aggressive pumping of funds into financial markets by the Federal Reserve Board and other central banks. Investors are holding many of these funds in safe, short term government securities until they invest them elsewhere. And they are cautious about selling safe, albeit low yield, investment and buying higher yield, longer term assets since there is still uncertainty about the value of all fixed assets. Some are mortgage related; others may drop sharply in value in a slowing economy. Also, investors have already priced in another 50 basis point or more cut in the FRB discount rate in two weeks.

The flip side of the coin is that the uncertainty about the value of longer term assets has increased the risk premium that investors need to buy them. The recent surge in inflation is also contributing to higher long term rates. The equilibrium for mortgage rates is the sum of the cost of short term funds plus inflation expectations. While still contained, inflation expectations have increased with $100 plus oil, soaring food costs and rapidly rising US import prices as the exchange value of the $US continues to fall.

The consequence for construction is that homes have become less affordable over the last month and the early 2008 surge in mortgage refinancing application has been reversed.

Overall, Reed Construction Data still believes that the problems in the financial market are being contained and will become less burdensome to the construction market during the balance of 2008. The financial environment remains volatile. So there will be brief periods, such as in January, when mortgage rates decline significantly as well as brief periods, such as February and March, when mortgage rates jump significantly.

Member Comments

» View all comments (2 total comments)

03/04/2008 - posted by L. Bancroft

I fail to see the mystery that Mr. Haughey is trying to solve. Long-term interest rates always move independently of short-term rates. Short-term mortgage rates like the rate for adjustable rate mortgages have fallen in line with other short-term rates as you would expect. The divergence between long term mortgage rates and short-term rates can continue as long as the Fed keeps short-term rates artificially low and concerns about inflation keep long-term mortgage rates high. In fact, if the policies of the Fed are fueling fears of inflation, long-term rates will continue to rise. Mystery solved.

03/03/2008 - posted by M. Drysdale

Homes may have become less affordable over the last month, as Mr. Haughey says, but they have become more affordable over the last year. 30-year mortgage rates are still lower than they were a year ago and housing prices have plummeted. The constraint on home purchases is not interest rates but lenders tightening standards for mortgages. Even then, the lending standards are merely returning to normal and, for that matter, housing prices are returning to normal after increasing nearly 150% in 10 years.

The problem for the construction industry isn’t volatile financial markets but the threat of a recession. …

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