Mortgage Rates

As the Federal Reserve Bank continues to raise interest rates, as a result of an elevated Federal Funds Rate, the Fed is essentially establishing a higher “floor”, so to speak, for interest rates charged on government debt. And on corporate debt as well.

The Fed does not directly set mortgage rates. Rather, the Fed influences mortgage rates through its role in determining monetary policy. Then too, the Fed indirectly affects ancillary interest rates which are available to borrowers in the marketplace in how credit spreads evolve in the market as a result of the Fed's actions. In relation to the issuance of debt instruments.?

Credit spreads consist of the purchase of - then the simultaneous sales of - contracts within the same asset classes. Credit spreads are not always so easily predictable. Then too, mortgage rates are not necessarily nor definitively so easily predictable either. Although the general direction mortgage rates will end up heading can rather accurately be predicted.

Higher interest rates established by the Fed set the higher benchmark on which acceptable credit spreads are determined by investors. As the Fed has steadily raised interest rates, the Fed's direct actions in relation to its tightening of the money supply has moved us out of the low interest rate environment we had been in. That low-rate environment having served as the "fuel" for elevated levels of home purchases, and of corporate borrowing. As the Fed has raised the Federal Funds Rate, mortgage rates have accordingly followed.

On December 30, 2022, the yield on the most widely tracked government debt instrument - the 10-year Treasury -?was 3.879. The 10-year Treasury establishes the benchmark for corporate debt, as well as for interest rates on a 30-year fixed rate mortgage. On December 29, 2022, while the 10-year Treasury yield was 3.879, the average interest rate on a 30-year fixed rate mortgage was in the mid-6% range.?

In relation to the subject of 30-year fixed rate mortgages, how these fixed-rate mortgages are established and made available to home buyers, and how mortgage capital is ultimately priced within the marketplace, we can look at the issuance of government debt obligations.

The United States government issues debt obligations on an ongoing and continual basis in order to finance capital spending. For example, the United States government may issue bonds to cover costs related to infrastructure projects. Or to fund budget deficits. One such debt obligation issued by the United States government is the 10-year Treasury note.?

Interest is paid on a 10-year Treasury note at six-month intervals. The 10-year Treasury has a ten-year maturity. When an investor purchases a 10-year Treasury note, that investor is making a de-facto "loan" to the United States government. The government will in turn use that "loan" it receives from the purchaser of the Treasury note to finance itself. So, in essence, when you purchase a home, and when you obtain a 30-year fixed rate mortgage to finance the acquisition of your home, you are financing not only your home. You are also contributing to the financing of the daily operations of the country in which you live, through the payments you make on your home loan.

The United States Treasury Department issues 10-year Treasuries with a minimum price of $100. Treasuries are issued in increments of $100. Interest paid by the United States government on 10-year Treasuries is determined by the bond's coupon rate. We can look at how bonds issued by the Treasury Department become available in the marketplace, and at how as Treasuries enter the marketplace, interest rates borrowers obtain on the 30-year fixed rate mortgages they use to finance their home acquisitions are established.

The Federal Reserve Bank conducts an auction. Auctions of 10-year Treasury notes are announced in February, May, August, and November. At these auctions, the Federal Reserve Bank offers bonds to registered investment banks. Once the investment banks purchase 10-year Treasury notes from the Fed, the investment banks make those bonds available to their own investors. Interest paid by the United States government on the issued bonds is called the coupon yield. As the market absorbs the issued bonds, a market yield is established.

When there is a socioeconomic environment in place which constitutes relatively high levels of market demand for 10-year Treasury notes, investor bids for these notes would most likely come in at or above a bond’s face value. The higher offer prices for the bonds will drive down bond yields, because investors are willing to accept the lower coupon rate they receive for the bonds in exchange for the de-facto loans they are making to the United States government by way of their purchase of 10-year Treasuries.

When investors determine that there is market volatility, investors may be inclined to accept a lower yield on their “loan” to the United States government. The investor's determination of the "volatile" market could lead the investor to arrive at a conclusion that government bonds are a safe place to park their money, as compared to other available investment vehicles they have available to select from (i.e.: the stock market).?

As 10-year Treasury note prices drop - and as yields on those bonds rise, in direct correlation to the price drops - so too will interest rates rise on 30-year fixed rate mortgages.?

On June 1, 2022, the yield on a 10-year Treasury was 2.913. On June 2, 2022 the average interest rate on a 30-year fixed rate mortgage was in the low-5% range. Whereas, six months earlier, in January, interest rates on a 30-year fixed rate mortgage were in the mid-3% range. On January 3, 2022, the yield on a 10-year Treasury note was 1.628.

As yields on 10-year Treasuries rose this past year - as 30-year fixed rate mortgage rates so too did rise for home buyers - investors who purchased Treasury bonds with the higher yields benefitted through the higher interest income they received on their bonds. So as monthly mortgage payments rose for home buyers this past year as a result of the higher mortgage rates in 2022, what simultaneously so too did rise was the earned income opportunity for those who owned bonds.?

The general imbalance we experienced in recent times - an imbalance partially arrived at through a low Federal Funds rate/low bond yields/low mortgage rates - led not only to an over-exuberance in the housing market. The low interest rate environment we just came out of also led to lower amounts of "carried" income having been received by holders of bonds. Those lower-yielding bonds having served as the very vehicle which established the ultra-low interest rates on the 30-year mortgages which fueled the housing frenzy we just experienced, up through the early parts of 2022.