Feds dropped interest rates. Do we care?
I was going to write a happy news post last week commenting on the Feds lowering interest rates for the first time in 11 years. However, after a week of turmoil and trade disputes reaching alarming levels, it's becoming clear that the move to lower interest rates is not an indication that the Feds have brought more keggers to keep the party going. It's more like the Feds have hired a bunch of security guards because some people are totally wasted and the party is getting out of hand.
The statement from the Chair of the Federal Reserve, Jerome Powell, indicates that his biggest concern comes out of global, not domestic, concerns. The ongoing, spiraling trade war between the US and China presents the biggest headwinds and instability, but other countries are starting to adopt protectionist trade policies that are rooted in old fashioned nationalism. Yay! We're reaching peak 'good old days' nostalgia!
More important for us here in the US mortgage industry, the global risk is causing investors to move all their cash from equities to bond safe havens, driving up the price of treasuries which, as we all know, have an inverse relationship with interest rate yields. Look at the chart on 10 year treasury yields above (10 year treasury has the greatest influence on mortgage interest rates). Yields have dropped 30 bps in just 1 week!
Just one look at 30 year fixed mortgage rates over the past year clearly shows why we've all been doing such good business. But while you may think that a further drop in interest rates due to this bum rush into bonds is good for you, it's going to be a painful transition for a lot of the lenders that you work with.
That's because a lot of lenders make forward commitments on the loans your originate for them, meaning they've promised investors that they will deliver a certain volume at a specific interest rate on loans that have not closed yet. Yes, lenders count their chickens before the eggs have hatched.
Knowing that there's a chance that some of their loans won't actually cross the finish line, lenders back up their promise with a hedge position to cover any potential losses.
But with the potential for a big drop in mortgage interest rates, there's an even greater chance that your borrowers will change their minds and hold off for a lower interest rate, crushing a lender's current hedge position because they didn't anticipate that global financial markets would obliterate their committed pipelines. Now lenders have to take an even bigger hedge position to cover even bigger potential losses, making things very tight for them in the short term.
Rob Chrisman, the mortgage industry guru, has a great write up on the impact of margin calls and mortgage-backed securities that is much more interesting than it sounds.
Of course, if a drop in interest rates stokes a massive rally in origination volumes, everyone will be happy in the long run. But don't expect the lock desk at your lenders to be in a festive mood. It's going to be rough going for them for a while. In fact, you might want to shower them with empathy.