Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market.
When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other "securitizers". These "securitizers" get their money by issuing bonds to bond market investors. These bonds are called "mortgage bonds" or "mortgage-backed securities". Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market.
As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive down interest rates and stimulate the economy. Since 2009, the Federal Reserve has purchased a staggering $1.7 trillion of mortgage bonds, and they’ve been the largest buyer of bonds in the market.
This has had the impact of keeping interest rates very low. In October 2017, the Fed began reducing their bond purchases, and they expect to gradually phase out their bond-buying program throughout 2018. This has caused mortgage rates to go up, and the trend toward higher rates is likely to continue. We will be watching the news, economic reports, and speeches from Fed policy-makers very closely to see how this tapering program continues to impact the market in the months ahead.
Another major factor that may impact mortgage rates is the growing level of federal government debt. This is causing an increased supply of Treasury bonds to hit the market. This large increase in bond supply is taking place simultaneously with the large reduction in bond demand that is resulting from the unwinding of the Fed’s bond-buying program as described earlier. This could cause interest rates to continue going up in 2018.
It will be interesting to watch how the market reacts to all these trends in the coming months.
Conclusion: we anticipate continued volatility in mortgage rates over the next several months as bond investors and the Fed decipher the trends that we've outlined above.
Source: CMPS Institute
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