So the Federal Reserve cut rates again. Many mortgage applicants are calling their mortgage representative and expecting a lower interest rate. Others who have been waiting to refinance are puzzled as to why mortgage rates have not moved lower during recent 5 Fed rate cuts. In fact mortgage rates are now higher than they were before the Fed began cutting rates by in January. This is difficult to explain to many consumers who have watched a 2.5% reduction by the Fed with no benefit in mortgage rates.Is a Fed rate cut really good news for mortgage rates? The facts may be surprising. The Fed can only control the Discount Rate and the Fed Funds Rate. This is very different from mortgage rates. A mortgage rate can be in effect for 30-years, a rate that is set by the Fed can change from one day to another.Another common mistake is in thinking that 30-year Treasury bonds or 10-year Treasury notes are directly pegged to mortgage rates.Those are government securities that are backed by the full faith and credit of the U.S. government and have no direct effect on mortgage rates.So what are mortgage rates based on? As it turns out the answer is mortgage-backed bonds known as Mortgage Backed Securities (MBS). Bonds issued by Fannie Mae and Freddie Mac (MBS) and the trading performance of those bonds will determine the direction of mortgage rates. Finding the catalyst that causes mortgage bonds to move will give you the keys to finding out what makes mortgage rates rise or fall.We know that inflation will always be a negative for any long-term bond because it eats away at the future returns. Since the bond will pay a set amount over a long period of time, that amount will be less valuable if inflation is high. Over the past several years, one catalyst that seems to be working in the opposite direction of MBS prices is the Nasdaq and broader stock market.As bond prices rise, interest rates fall. As bond prices fall, interest rates rise. The charts accompanying this article show the Nasdaq Composite Index and the Fannie Mae 6.5% mortgage bond tend to follow paths that are almost mirror images of each other. The consistency of this behavior is astounding.As the Nasdaq moves higher, bond prices move lower causing interest rates to rise. As the Nasdaq declines, mortgage bonds benefit, causing mortgage rates to fall. Additionally, and unlike common opinion, Fed rate cuts have had virtually no direct effect on mortgage rates. Moreover, it appears that since Fed rate cuts act to stimulate the Nasdaq, they have a negative effect on mortgage rates. 

The bottom line is that it appears mortgage rates will get better if the Nasdaq sells off and will get worse if the Nasdaq rallies. So it is not necessarily what the Fed does that affects mortgage rates, it’s how the Nasdaq and broader stock market interprets the Fed’s action that will ultimately influence the direction of mortgage rates. This is because money managers and mutual fund companies typically keep funds in either stocks or bonds with very little in cash. If stocks are in favor, money is pulled from bonds, causing bond prices to drop and interest rates to rise. When stocks are being sold off, the money is then parked into bonds, which improves bond prices and causes interest rates to decline.On the chart of the Nasdaq Composite Index above, notice how the price movement higher on the Nasdaq seems to correlate to mortgage bond price deterioration (shown below) and vice versa. Once again, lower bond prices translate to higher mortgage rates and higher mortgage bond prices mean lower mortgage rates.The chart below shows how the Fannie Mae 6.5% mortgage bond has performed during the same time period. The green circles indicate Fed rate cuts and the area circled in red shows when the Fed hiked rates.

A closer look at the 5 rate cuts by the Fed this year (see chart below) shows that mortgage bond prices deteriorated after each Fed rate cut. This means that mortgage rates rose after the Fed had cut rates while many consumers were expecting their mortgage rates to decline. Worse yet are the consumers who missed the opportunity to obtain a lower rate because they mistakenly waited for the anticipated Fed action to cut short-term rates, thinking that longer-term mortgage rates would decline as a result.

Predicting the future is tough, so nothing is written in stone. Keep an eye on the Nasdaq, and keep in mind that the best rates may be behind us. But, mortgage rates are still low and could have some quick dips so make the most of them while they last. 

Citigroup Inc., the biggest U.S. bank, may need additional capital from outside investors as losses stemming from the collapse of the U.S. subprime mortgage market increase. Bond market quiet and relatively unchanged. Stock futures point towards a lower open after Intel Corp. said lower chip prices will hurt earnings.

Here we go again…another action packed week in store, with the main event being Friday’s monthly official Jobs Report. This report is always of high interest, as it gives a good read on the health of the economy. Boiled down simply — if businesses are hiring, it means their outlook is good for the future growth of their business and the economy overall. Additionally, the more employed workers there are, the more dollars being earned that can be used to buy goods and services - also good for keeping the economy thriving.But the headline number often comes with “revisions” of past numbers — which is often the wildcard within the report. Some past revisions have actually added more jobs to the count than the current month’s number in total. And for added excitement, in advance of Friday’s official Jobs Report, gigantic payroll company ADP will release their own count on job growth on Wednesday. And while the numbers are not “official” and are sometimes seen as unreliable — the markets won’t be able to help but take notice of their findings, and may react to their release.Bottom line — volatility remains in vogue. The chart below shows how Bonds improved significantly over the past week, helping home loan rates improve as well. But remember — another Fed Cut is likely in the cards, just a few short weeks away. As we’ve discussed in the past, a Fed Rate Cut can often result in a move higher for home loan rates, as a Fed Rate Cut often spurs on spending and therefore inflation, the arch-enemy of Bonds and home loan rates. So while Bonds and home loan rates have seen nice improvement of late, they are heading towards both a technical “ceiling of resistance”, as well as a March 18th Fed meeting that could cause rates to worsen. If you - or one of your friends, family members, neighbors or coworkers - have been considering a refinance or purchase, feel free to reach out to me to discuss taking advantage of current low rates.

Chart: Fannie Mae 5.5% Mortgage Bond (Friday Feb 29, 2008)

“I DON’T MEASURE A MAN’S SUCCESS BY HOW HIGH HE CLIMBS…BUT HOW HIGH HE BOUNCES WHEN HE HITS BOTTOM.” General George S. Patton And the General himself would certainly consider Bonds to be a success last week, as they moved lower to hit a technical “bottom” at the 200-day Moving Average, but then bounced significantly higher throughout the course of the week, helping fixed home loan rates improve by about .25 to .375%.What caused all the activity? Remember that weak economic news tends to be bad for Stocks, but good for Bonds and home loan rates, as money flows out of Stocks and into Bonds. And last week had its share of weak economic news, combined with testimony before Congress by Fed Chairman Ben Bernanke.The news included higher wholesale inflation with the Producer Price Index (PPI) jumping to its highest level since October 2004 on surging energy and food prices. But price inflation on the producer or wholesale side can’t always get passed directly on to the consumer on the retail side. Friday’s Personal Consumption Expenditure (PCE) reading showed consumer inflation to be higher, but just slightly, as expected. The PCE is the Federal Reserve’s most highly watched measure of inflation, and the current overall rate of year-over-year inflation at 2.2% does remain just above the Federal Reserve’s comfort zone for consumer inflation.And speaking of the Fed, Chairman Ben Bernanke testified before Congress last week, making comments that prompted Stock investors to sell off and move money over into Bonds. The Bond market also enjoyed “dovish” comments made by Gentle Ben about inflation and the recent aggressive cuts made by the Fed, and his testimony was largely responsible for the improvement in Bonds and home loan rates. But read on, and learn how the next official Fed Meeting and Rate Decision on March 18th could impact home loan rates…it might surprise you.THE ECONOMIC STIMULUS PLAN HAS BEEN ALL OVER THE HEADLINES…BUT DO YOU KNOW HOW IT WILL IMPACT YOU? LEARN ABOUT REBATE CHECKS AND MORE IN THIS WEEK’S MORTGAGE MARKET VIEW!