This morning the Bureau of Labor Statistics released the monthly report on consumer inflation. The overall reading came in slightly worse at a month over month decline of -0.7%, the core rate which excludes food and energy came in slightly better at 0.0%. Year over year consumer inflation is rising at its slowest pace since the early 1960’s. Industrial production came in worse as well at a -2.0% drop when expectations where for a -0.8% drop. This report is very important as it is one of the major reports that measures economic activity. If industrial production is stronger that typically leads to higher inflation and when it is weaker it leads to lower inflation. As stated many times, the biggest enemy to mortgage rates is inflation. Since a mortgage backed security is a fixed income investment, inflation eats away at that return thus higher inflation leads to higher mortgage rates. To better understand this let me explain it this way. If you have a 30 year fixed rate mortgage, you are paying a fixed interest rate for 30 years. Now, there is an investor out there that owns your mortgage, so that investor is earning the interest that you are paying but the rate they are earning will be fixed. So, if you are paying a 6% interest rate, an investor is earning 6% but as inflation creeps in, the value of the future earnings get less and less.
We also got the release of consumer sentiment which came in slightly better but it has caused no movement to mbs pricing as the number is still historically horrible. Currently, mbs are down 4 ticks on the day and yesterday we closed down 6 ticks. This has lead to some lenders repricing for the worse but we are also getting reports that some lenders rates are the same or better then yesterday. At the current price levels of mbs, we should be seeing much lower interest rates. Until lenders can get caught up on their current pipeline, they will be slow to improve rates. If you are closing within a week, locking would be a good call and hopefully you followed that advice from yesterday. If you are closing more then a week or so, floating will probably pay off. As more time passes, it will allow lenders to pass along better interest rates.
There are a few things present that should prevent a big sell off of mbs and higher mortgage rates. First, at the current price of mbs, we should be seeing par interest rates of 4.25%. So even if mbs stay at current levels better pricing will eventually come from lenders. Next, we have a pretty good floor of support right beneath current levels. When ever you hear me speak of floor of support or ceiling of resistance, these are technical terms known to most traders. An easy way to understand this is to look at the room you are currently in. You can move fairly easy between the ceiling and the floor, you just have to jump up and down. Now, lets say you want to go beneath the floor. Much harder to do, you will have to get a shovel or something to dig beneath. So it is hard to move below the floor, but it is possible to do. Just like if you want to go through the ceiling, it requires much more work but moving between the floor and ceiling is fairly easy. Third, we have the Federal Reserve ready with $500 billion dollars to buy mbs. Since the beginning of the year, the Federal Reserve has bought about $50 billion worth of mbs so they still have $450 billion at their disposal. If we start to sell off, the Fed’s can step in as a buyer to keep the price of mbs up. As the price of mbs moves higher, mortgage rates move lower and vice versa. Finally, most economic reports that have been coming out have been favorable to mbs. Inflation is low, unemployment is high and most of us will agree that the economy is not doing very well. We are in a recession and the general rule is bad economy leads to low mortgage rates.
Today is a shortened trading day due to the Martin Luther King Jr holiday on Monday and all banks and trading will be closed Monday. If anything major breaks I will get back to you.