Mortgage Rates Take a Surprise Turn

The housing industry spent much of 2013 worrying about how much mortgage rates would rise once the Federal Reserve started unwinding its aggressive stimulus program. Since the Fed started to downshift that program though, 30-year fixed mortgage rates have gone down, not up. What gives?

Ultimately, economic data tends to trump what the Fed is doing. Despite the Fed's optimism about the economy, recent signs suggest that growth may be slowing. The stock market, the bond market, and mortgage rates all seem to be siding with the data rather than the Fed.

While the Fed is optimistic...

The Federal Reserve's quantitative easing program was designed to bring down mortgage rates and other forms of long-term interest rates by regularly buying long-term and mortgage-backed bonds. This program was instrumental in bringing about the record low mortgage rates of recent years. In December, the Fed announced that it was cutting the $85 billion monthly purchase program by $10 billion. In January, the Fed announced it was cutting the program by another $10 billion, to $65 billion.

The quantitative easing program had to be unwound at some point, and the Fed's premise for starting to do it now is that economic growth has improved in recent months. To some extent, that seems to make sense. According to the Bureau of Economic Analysis, GDP growth improved in each of the first three quarters of last year. Recently though, there are some more troubling signs about the economy - and those signs have gotten the attention of investors.

...recent data releases are not

So far, it has not been a happy new year for the US economy. Here are some key economic releases so far in 2014:

  • According to the Bureau of Labor Statistics, job creation dropped to 74,000 in December, down from an average of 220,500 the prior two months.
  • The Census Bureau announced that new home sales declined by 7 percent in December, their second consecutive monthly decline.
  • An advance estimate of fourth quarter GDP by the Bureau of Economic Analysis showed inflation-adjusted economic growth at a 3.2 percent annual rate during the quarter - not a bad growth rate, but down from 4.1 percent in the third quarter.
  • A survey of purchasing managers by the Institute of Supply Management found manufacturing conditions down  5.2 percent in January, with the outlook for future orders down 13.2 percent.

Investors are siding with the data

So far, the financial markets seem to be putting more belief in these gloomy financial data releases than in the Fed's optimism. The stock market dropped by 3.6 percent in January, while 10-year bond yields fell by 0.37 percent.

Bond yields are a form of long-term interest rate, so their behavior tends to correlate with the direction of mortgage rates. According to mortgage finance company Freddie Mac, 30-year fixed mortgage rates have now dropped by about 20 basis points since the Fed first announced it was tapering back its quantitative easing program. If the bond market is any indication, mortgage rates might have even further to fall.

Will 2014 see a return of record low mortgage rates, or at least 30-year fixed mortgage rates below 4 percent? It may be unrealistic to expect mortgage rates to return to the lows reached early last year, but if economic news continues to be disappointing, getting 30-year fixed mortgage rates down to the 4 percent mark is not out of the question. On the other hand, if the Fed's optimism about the economy proves to be well-founded, expect mortgage rates to start rising again.

For prospective home buyers, or home owners looking to refinance a mortgage, these two outcomes present something of a dilemma: whether the return of low interest rates would be worth the consequences of a weakening economy. Those contemplating applying for a mortgage need to keep a close eye on economic news in the coming weeks for clues as to which way rates may be headed next.

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