As Bond Interest Rates Fall, Will Mortgage Rates Follow?

A strong rally in the bond market could help reverse a trend which has seen mortgage rates rising steadily since hitting an all-time low in April. This would naturally be of interest to anyone thinking of buying a house, but it should also benefit homeowners as well, especially those who want to refinance their mortgages.

At the heart of this is the interrelationship between mortgage rates and bond market interest rates, especially the yields on U.S. Treasury bonds.

Long Bonds and Mortgage Rates

Treasury bond yields do not match up exactly with mortgage rates, but they tend to be influenced by many of the same forces. For example, a 30-year bond and a 30-year mortgage both are obligations to pay a certain amount of principal and interest over the course of 30-years. As such, they are sensitive to inflation--the higher the rate of inflation, the higher the interest rate will have to go to compensate for the loss of purchasing power. They can also be sensitive to other factors affecting interest rates, such as the supply and demand of capital, and the perceived degree of credit risk.

Because Treasury bonds are freely traded, they represent an up-to-the-minute market consensus on the outlook for inflation and interest rates. Mortgage rates are set by lenders, and thus may be a little slower to react than Treasury bonds, but ultimately they will move to reflect much of the same consensus about market conditions as the Treasury market.

Reversing the Recent Trend in Interest Rates

Because of this relationship, it is significant for mortgage shoppers that Treasury yields rose steadily from the start of the year till early June. Mortgage rates lagged behind this trend a little bit, continuing to fall into April, but then rising 81 basis points from April 30th till June 11th.

In the latter half of June, Treasury yields reversed their upward trend. Treasury bonds rallied, and when bond prices rise, market yields fall. While there is no guarantee that mortgage rates will follow suit, there is a good likelihood that they will. Indeed, after rising sharply in early June, mortgage rates have since eased somewhat.

Historical Perspective

With all this talk of rising and falling markets, a little historical perspective on mortgage rates is helpful. When 30-year mortgage rates hit 4.78% in April, that was the lowest they have ever been. In fact, 30-year mortgage rates had never been below 5% at any point until this year. So, even after climbing 81 basis points, they were still lower than they had been at just about any other time in history.

So, mortgage rates are already low, and the possibility that they may go lower would only add to the good news.

Benefits of Lower Mortgage Rates

Just who would benefit from that good news? Naturally, new mortgage shoppers would find themselves paying less in interest expense. Some existing homeowners would be able to refinance if mortgage rates fell again. Even homeowners who didn't refinance would derive some benefit from lower mortgage rates, because by drawing more people into the housing market, lower rates provide support for home prices. More broadly still, lower interest rates act as an economic stimulus, and so a turn back downward in mortgage rates would help the economy emerge from the recession.

 

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