OPINION - U.S. Mortgages and Rates by David Beadle
Friday October 25, 10:55 am ET
By David Beadle, mortgage industry analyst, BestRates Inc.
NEW YORK, Oct 25 (Reuters) - A lot has been made recently of
the possibility we may be facing a deflationary spiral. In theory,
that should be good news for those seeking lower mortgage rates,
even though deflation could be very bad news for the U.S.
economy.
Deflation is triggered by an overabundance of goods and
services met with little demand from consumers. In order to keep
the factories humming, manufacturers are forced to lower prices to
a level where shoppers cannot resist the bargains.
And the best domestic example of the trend is the drop in
mortgage rates seen for the past half year. Thanks to the Federal
Reserve Board, there is plenty of cash sloshing around in the
pipeline. The problem is that businesses don't need the money for
capital expenditures.
Why? Because factories are currently only operating at roughly
75 percent of capacity, so there is little demand for expansion
capital.
Many companies which do wish to borrow funds for continuing
operations in a tough sales environment are finding the asking
price for money is astronomical. Investors are demanding a
double-digit return on their cash, because of uncertainties about
the integrity of corporate balance sheets in the wake of all the
recent scandals and restatements of earnings.
The major bond rating agencies are issuing more downgrades
than upgrades, and only the highest rated firms are able to
receive rates below 10 percent when they issue IOUs.
In sharp contrast, home mortgage rates are near 40-year lows.
There are two primary reasons for this divergence. The first is
that investors perceive home equity as being among the safest
places for their cash in troubled times, and a much better
alternative than lending to businesses.
The second reason is the perception that the two major buyers
and consolidators of mortgages have an implicit government
guarantee if property values were to plunge and home owners began
defaulting on their loans in large numbers.
However, in recent months, this latter assumption of a
government bailout of mortgage investors if a full blown crisis
were to occur has been questioned by at least one congressional
committee. And for that reason, there has been a shift by some
money managers into FHA and VA mortgage backed securities. The
result has been a faster drop in Federal Housing Administration
(FHA) and Veteran Administration (VA) loan rates than standard
loan rates.
The one situation which has historically frightened the bond
market has been one where prices are rapidly rising, otherwise
known as inflation.
Generally, upward price pressures have prompted investors to
demand a "premium" on their rate of return, to offset inflationary
expectations.
For instance, if a certificate of deposit at the bank is
paying 3 percent and inflation is running at zero percent, the
"real" rate of return is 3 percent. But if inflation is 3 percent,
the "real" rate of return after accounting for inflation is zero.
Therefore, in a 3 percent inflationary environment, investors
often demand a 3 percent buffer, which would put that certificate
of deposit at 6 percent, to provide a real rate of return of 3
percent.
But if the price of oil as a result of a new Gulf War were to
spike from the current roughly $30 price to perhaps $40 or $50,
mortgage rates might not rise.
In fact, they could even decline. The reason is simple. The
price of oil is now seen as an extra "tax" on consumers when they
fill up at the gasoline station. And that's money which won't be
spent at the department store on holiday gifts. Thus, the economy
could suffer another blow, which would bring about the specter of
rampant deflation. And as we've already seen, deflation usually
pushes mortgage rates lower.
In summary, we appear to be in a potential "win/win"
situation, when it comes to the interest rate environment. Prices
go down, and rates go down. Oil prices go up, and rates go down.
But there are risks. The biggest one is a ballooning
government deficit to pay for the war effort. In that scenario,
the U.S. Treasury would be borrowing a huge amount of money and
this set of circumstances would almost certainly put upward
pressure on rates, as there would be fewer investor dollars left
to finance home loans. The question is whether or not the economy
would slow sufficiently to offset the impact.
As we get into the new week, here are what some key indicators
are telling us. A plus (+) sign means the category is on the side
of lower interest rates, a minus (-) sign means the forecast is
for higher rates, and a zero (0) means the item is giving a
neutral reading.
Key Indicators
0 Treasury Yields
0 Currencies
0 Inflation
0 Energy Prices
0 Precious Metals
0 Chart Patterns
(Note: The opinions expressed here are those of the author.
They should not be seen as representing the views of Reuters.) |
