Disap-half-point-ment

Long Bond Yield : 5.31% (up 2 BP)
10-year Treasury : 4.78% (unchanged)
Fannie Mae 10 day delivery rate : 6.87% (up 9 BP)
30Y/FNMA yield spread : 156 BP (up 5 BP)
10Y/FNMA yield spread : 209 BP (up 9 BP)
10-Day Delivery rate a month ago : 7.20%
10-Day Delivery rate a year ago today: 8.21%

Good day lenders. This past week home loan rates gave back half of the gains we realized for the week ending 3/16/01. The “why” of what happened is infinitely more compelling than the “what” of the past week.

My greatest fear for the week did not come to pass. There was a great deal of speculation that the Fed could lower the short-term rates they control by 75 basis points. Had they done that, it could have provoked a massive reverse flight to quality resulting in serious damage to home loan rates. Why? It would have sent a signal to the financial markets that the Fed was more concerned with equity prices than price stability (aka inflation). This would have launched stock prices higher and the credit markets would have more than likely have taken a big hit in the process. The potential for this still exists should the Fed pull a “surprise cut” before the May 15 scheduled meeting of the FOMC.

There was an important lesson for everyone to learn this past week about the movement of home loan interest rates. How many times have you heard someone in the media (or in person) say, “Home loan rates will fall when the Fed cuts the short-term rates” that they control? In reality, the only direct connections with the Federal Reserve’s short-term rate manipulations and homeloans are equity lines of credit which are tied to the prime rate, and some (not all) variable rate home loans. Yet every time it is anticipated that the Fed will cut rates, the expectation is also there that interest on fixed rate loans will decline. Yes, what actually happens to the interest on home loans when the Fed cuts short-term rates is radically different from popular perception. However, since the masses do not understand this, expect a surge in new loan applications for refinancing to be reported by MBA for this past week as a result of the Fed rate move.

Okay, so what is going on with rates and why do I think they are headed higher? Investors in mortgage-backed securities are fearful of prepays as it can cost them lost principal. This is particularly true with “bundles” of mortgages that had rebate pricing to brokers to cover part, or all, of the fees and costs. As the magnitude and intensity of a refinance wave grows, so too does the resistance level of investors in mortgage-backed securities. Now add to that the potential that stocks may have already seen the bottom, and you can put the rest together for yourself.

The mortgage-backed securities market reaction to the Fed rate cut was a resounding nothing. Tuesday morning opened with the Fannie Mae delivery rate at 6.91%, the highest point for the week, and it closed (after the FOMC press release) at the same level. Between Wednesday morning and Friday’s close the delivery rate edged lower by a paltry 2 BP. Perhaps things might have been different if the CPIreport on Wednesday did not throw another inflation scare into the markets. The rest of the week’s news releases pales in comparison to the CPI increase of 0.3% for February and the 50 BP rate cut buy the Fed.

The only other interesting and very relevant news for the week was the Wednesday release of the Mortgage Bankers Association of America’s weekly index of new loan applications. While the overall index fell in week-over-week comparisons (thanks in large part to a 10% decline for new refinance applications) the number of new purchase applications rose. Doing my usual multi-year-over-year comparisons, this past week’s refinance index (seasonally adjusted of course) was 493.01% higher than the same week a year earlier, 54.06% higher than two years earlier and 53.45% higher than three years earlier. Even with the week’s improvement to the purchase index, it was down 2.80% from a year earlier. However, the purchase index was 15.57% higher than the same week two years earlier (a record year for home sales) and 38.03% higher than three years ago (also a record sales year). What do these numbers suggest to you?