Where are mortgage rates going?

March 14, 2011


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MARKET RECAP

Some people just can't help themselves; that is, they can't help but see the glass as half empty. RealtyTrac is finding itself slotted into that category more often than not. For instance, RealtyTrac reported that lenders filed foreclosures on or repossessed 27 percent fewer properties in February than in January, the lowest in three years and the biggest yearly decrease since 2005.

This sounds like good news to us. However, the overly pessimistic spin from RealtyTrac was that the slowdown was due mostly to mortgage servicers being disrupted by processing issues. "While a small part of February’s decrease can be attributed to it being a short month and bad weather, the bottom line is that the industry is in the midst of a major overhaul that has severely restricted its capacity to process foreclosures," said RealtyTrac CEO James Saccacio.

We don't want to disparage Mr. Saccacio, because there is some truth to what he says. Yes, the weather was bad in February, and, yes, mortgage servicers are trying to right a listing ship. But real improvement is there nonetheless – both in the overall economy and housing. We mentioned last week the significant improvement in the employment numbers, which is a direct reflection on the state of the economy. As employment improves so will the housing market, despite the intimidating numbers on foreclosures and inventory that worry economists.

These same economists tend to be drawn to repetitive language. “Shadow inventory” is part of that language, and the term was recently invoked by the Director of Research at Radar Logic, who referred to the concern of “severe supply of overhang” and “shadow inventory of homes in default or foreclosure.” We are compelled to ask the obvious: Because we are all aware of the problem, is shadow inventory really in the shadows anymore? What's known is rarely the issue; it's the unknown that's the real issue.

Radar Logic went on to report that its price-per-square-foot index, covering 25 metro areas, is near an eight-year low. At $183.18 a square foot, the index price is 34 percent lower than its peak price of $278.32 a square foot, set in June 2007.

The text in which Radar Logic's data were delivered hinted at pessimism, but it's not pessimistic at all. This is good news; heavy discounting is over and recovery is much more likely than not. Today's market is a buyer's market, to be sure, but markets aren't the Harlem Globetrotters versus the Washington Generals (the hapless team offered as a sacrifice). The market will turn to favor sellers who bought at a low-cost basis. In other words, today's buyers.

In the meantime, today's mortgage rates remain favorable to all. Rates have held steady for the past month, and they are still lower than they were this time last year. This time next year, though, we would be very surprised not to be saying the opposite.

What Bill Says About the Bond Market
Bill Gross isn't as famous as Warren Buffett, though he is just as influential to bond investors. Gross runs the world's largest bond fund, PIMCO, and has been very successful over the years. Therefore, it's worthwhile to mention that his fund has eliminated all government-related debt, because Gross believes domestic interest rates are going higher. He says that yields on Treasury securities are about 150 basis points (1.5 percentage points) too low when viewed from a historical perspective.

This is important insight to borrowers. Mortgage rates, by way of mortgage-bond prices, track the yield on 10-year Treasury notes. The historical spread between the two is roughly two percentage points. The current 10-year Treasury note is yielding around 3.4 percent. Add 150 basis points and the same note would yield 4.9 percent. Add two percentage points to that, and we get 6.9-percent 30-year fixed-rate mortgages.

Over the past year, the 30-year fixed-rate mortgage has been around 160 basis points above 10-year Treasury yields, but that's due mostly to Federal Reserve intervention. However, the Fed isn't going to be intervening into perpetuity. When it stops, the spread will likely return to historical norms. So will mortgage rates.