A special guest post from David Battany, EVP Capital Markets
Below are key aspects of the current financial markets which may be helpful in understanding how current political events may impact mortgage interest rates going forward.
The price movements in the stock and bond markets reflect investors’ perceptions of future economic conditions, and should not be viewed as the market’s punishment or reward of any political viewpoint. Prior to November 8, the U.S. stock and bond markets expected a Clinton White House, with a Senate shifting to a slight Democrat majority, and a House that would remain a slight Republican majority. The market expectation was a divided Congress and White House, with a very gridlocked political process for the next two years, resulting in modest political changes and impact to the U.S. economy.
With the Trump victory, and Republicans having retained their majorities in the Senate and House, there is a much greater probability of new legislation moving forward in several areas that would impact the economy.
There are three key factors that will drive future interest rate levels:
- The Economy. The market’s perceptions of the future economic growth rate of the U.S. economy directly impacts interest rates. Good economic news causes interest rates to rise. In an expanding and growing economy, there is increased demand to borrower money and less need for government stimulus efforts to lower interest rates.
- Government Borrowing. If the U.S. government increases its borrowing amounts, this would impact the supply and demand balance between institutional borrowers and investors, causing upwards pressure on interest rates, particularly on U.S. Treasury security yields. If Trump reduces tax rates to increase economic growth, this would at least in the short term drive increased government borrowing. Additionally, if Trump increases spending on infrastructure projects, an increase government borrowing levels is possible.
- Inflation. Bond investors want to earn a return on their investments above the expected rate of inflation. If an investor wishes to earn 2% above the inflation rate, and the inflation rate is currently 2%, then the investor would need to charge a 4% rate. If inflation increases to 3%, investors would need to charge a 5% rate in order to earn a 2% after inflation return on their investment. Increases in the inflation rate lead to an almost 1:1 increase in interest rates.
Will the Fed raise rates?
There has been much chatter about whether or not the Federal Reserve (“Fed”) will raise interest rates during its December meeting. As a matter of background, the Fed Funds rate is the rate at which member banks of the Federal Reserve charge each other for overnight borrowings. The Federal Reserve sets the target for these rates which is presently 25-50 basis points. If the Fed decides to raise rates in December, it would likely pick a new target of 50-75 basis points.
The impact of a Fed increase in December could possibly have no impact on mortgage rates. One reason is that the market has already priced in the likelihood of a Fed increase into current price levels. Another reason is that an increase in the Fed Funds rate would raise overnight short term rates, but mortgage rates are typically priced more to the 8-10 year part of the yield curve, and may not move as much in proportion to changes on the short end of the curve.
The Fed is trying to achieve an annual inflation rate target of 2% for the U.S. economy. If inflation rates begin to increase more than 2% annually, the Fed will be more likely to announce additional Fed Funds increases. If inflation drops below 2%, the Fed will likely hold off on rate increases, and in some cases could actually lower the Fed Funds rate.
The President is allowed to appoint over 300 senior positions in the U.S. Government without Senate confirmation, in addition to Cabinet Secretaries and Supreme Court Justices which require Senate confirmation. Trump will be able to appoint new leadership positions in The U.S. Treasury, HUD, and the DOJ, to name a few of the agencies that will be impacted. As these new appointments are announced over the next 60 days, the market will be evaluating each new person’s expected views on key policies and how the economy may be impacted.
New GSE Loan Limits
The Fannie Mae and Freddie Mac conforming loan limits are reviewed annually, based upon the national change in home prices from October of the preceding year compared to October of the present year. If the home price data shows a national increase percentage in home prices year over year, FHFA who is the regulator of Fannie Mae and Freddie Mac, has the option to increase the base GSE loan limit by the same percentage. If there is an increase in the conforming loan limits, it is usually announced during the last few days in November, and is effective for loans delivered on or after January 2 of the following year.
The stock and bond markets will be carefully reviewing the Trump administration’s 100-day plan, discerning the top expected priorities, and reacting to announcements of political appointees in key government positions. During the next 60 days before inauguration, we will likely see very volatile market price swings, up and down in price, often within the same trading day. This volatility will likely continue for several months until all appointees are announced and legislative priorities are publicly communicated.