Thursday, December 8 2022

Most of the following are an updated version of the same coverage from yesterday. Not much has changed today other than the Heavy Works report pushing rates higher once again. This only exacerbates the problem discussed in yesterday’s comment.

Without a shadow of a doubt, average lender mortgage rates are significantly higher this week compared to last week, with Friday being the worst of the bunch. Despite this fact, there have been several reports this week of a massive DROP in rates. What’s up with that?

Before we continue, you might be wondering who you can trust if you get two totally different stories. Luckily, you can trust both stories! The one on lower the rates just need some qualification.

This week’s misleading headlines are invariably the result of Freddie Mac’s weekly mortgage rate survey. It is the oldest and one of the most popular records of how interest rates have changed over time. The majority of news organizations use it as their primary source for their weekly rate coverage.

In more normal times, this strategy is quite good. The heavy consumer of financial news doesn’t particularly need a new rate update every day (unless they’re teleshopping). And Freddie’s data does a great job of capturing broad, long-term rate trends.

Unfortunately, it makes a terrible tries to capture rate changes when bonds are experiencing high volatility, especially if that volatility is occurring in the last 3 days of the week.

Here’s why (in 2 levels of detail):

The most basic level: Freddie publishes his survey results on Thursday, but collects most of the responses on Monday/Tuesday. This means that news outlets are actually reporting a Monday/Tuesday rate versus the Monday/Tuesday rate of last week. If there is a big move in rates from Wednesday to Friday, the headlines may suggest that rates made a big move in one direction when in fact they did the opposite.

The most detailed level (go to “MBS Award” if you are satisfied with the basic level): Freddie sends out the survey Monday morning and receives the majority of responses within 24 hours. It continues to accept responses through Wednesday, although daily rate data suggests Wednesdays have almost no impact on the outcome. The results are not published until Thursday morning.

This creates an obvious problem: by the time rates are released on Thursday, they can be significantly higher or lower than they were at the start of the week. The problem is compounded by the fact that the previous week saw volatility the other way around.

For example, if last week’s rates were high on Monday/Tuesday, then dropped on Wednesday/Thu, Freddie’s survey would register way too high. Then, this week, if rates were simply unchanged at the start of the week, Freddie’s survey showed a large drop of the previous week. From there, if rates rise again, by Thursday rates could be significantly upper than they were the previous Thursday. At the same time, hundreds of news organizations and social media posts were blasting headlines about “much lower rates.”

MBS Award

Mortgage rates, as offered by mortgage lenders, tend to be updated only one to three times a day, depending on market volatility. But the bonds that determine mortgage rates (mortgage-backed securities or “MBS”) are changing permanently. The graphical representation of this movement shows us the forces in real time affecting the rates. The only problem is that MBS prices move inversely to interest rates. For instance:

With that in mind, let’s take a look at MBS price movement over the past few weeks to uncover the big deal with Freddie’s rate survey.

20220708 NL2.png

Conclusion on mortgage rates: the timing of the last 2 Freddie Investigations was as bad as it could have been when it came to painting a misleading picture of reality. This resulted in headlines proclaiming a near-record weekly drop in mortgage rates on Thursday – the same day that rates were already significantly higher than most of the previous week.

In other economic news this week, we can see some of the data responsible for the upward pressure on rates. Typically, rates rise when economic data is stronger than expected (with expectations based on economist forecasts).

There have been two important economic reports this week: Wednesday’s report on the health of the service sector and Friday’s official employment data. Both were stronger than expected. The following chart shows 10-year Treasury yields, which correlate well with mortgage rates.

20220708 nl5.png

While those reactions have been pretty clear, next Wednesday brings the possibility of a much bigger reaction. This is when the next installment of the monthly Consumer Price Index (CPI) is released. While the jobs report has traditionally been the most important economic report for rates, the CPI is currently much more important as it is the most-watched inflation index in the United States (and the inflation is driving the massive rate hike in 2022).

Markets approach next Wednesday with an open mind. CPI is the biggest game in town, but it’s not the only one. To use a timely example, the services sector data mentioned above (technically the ISM non-manufacturing index) also has a “prices paid” component. This is one of the many ways market participants follow price trends. Obviously, prices are still very high, but like several other economic reports, the trend suggests a potential change.

20220708 nl1.png

All that to say, investors aren’t heading into the big CPI data with the goal of pushing rates up or down. The market is agile at current levels and should react relatively logically. Specifically, a sharp decline in inflation would almost certainly lower rates, while a sharp rise could easily push us back to recent highs.


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