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Mortgage Rates Much Lower After Debt Deal

Mortgage rates fell significantly today, returning in line with the lowest levels seen in recent weeks for some lenders.  Not every lender experienced the improvement in the same way, however, with some still not back to last week’s best offerings.  Whatever the case, the average top-tier Conforming 30yr fixed rate is back to 4.25% .

Despite our analysis suggesting rates didn’t care about fiscal drama as much as they cared about economic data, and despite rates making it right back to pre-shutdown levels, the past week had seen them move higher than they otherwise might if they truly didn’t care about the fiscal drama.  And now they’ve moved significantly lower due to the fiscal drama subsiding, one might wonder what gives.


Rates actually did quite a fine job of holding steady during the first part of the shutdown, and the sense that markets were more concerned with economic data and Fed policy was reinforced.  Indeed, the shutdown itself was of little concern for rates.  The approach of the debt ceiling, however, had a domino effect that ended up doing some damage.


To understand the damage, we need to understand something that rarely comes into play in a discussion of mortgage rates but is always operating silently behind the scenes: the short term funding market.  This simply refers to the shortest term borrowing and lending that takes place in massive quantities each day in financial markets.  These are the transactions that have shorter time windows than the 2yr Treasury notes, and range all the way down to “overnight” maturities.


This is the lifeblood of all other lending, and it never usually makes the news because it’s never stirring the pot in the same way it just did.  Of course market participants assumed that the risk of a default would take a toll on these short term funding lines, but the toll ended up being much bigger than expected.  If we consider 1-month Treasury bills, for example, the very worst of the 2011 budget battle brought those yields to 0.25%.  By comparison, Tuesday night saw them hit 0.50%.


It was by far the biggest spike in short term funding costs we’ve seen since the onset of the Financial Crisis and it dealt an unexpected blow to the longer term debt market.  That means that securities such as the 10yr Treasury and the Mortgage-backed-securities (MBS) that dictate mortgage rates were noticeably affected.  Were it not for this short term debt market surprise, longer term rates like mortgages may well have not budged much at all.


Now that the debt deal has been reached, those short term debt markets have thawed quickly, and mortgage rates have been able to correct accordingly.  In addition to that, Fed speakers have been unified in suggesting that this fiscal uncertainty and the unknown impact on the economy from the shutdown likely means that any decrease in Fed asset purchases is on hold for the next few meetings (meaning tapering gets pushed into 2014).  This only adds to the momentum lower in rates, making the snap back to the best recent levels especially quick.