Huge Decline in Mortgage Yields and Spreads Could Dispel Deflationary Gloom

This is unprecedented. Since the end of October, the yields on FNMA mortgage-backed paper have fallen over two and a half percentage points, to an all-time low of 3.42% today. Yields on the reference 10-year Treasury have fallen one and a half percentage points over the same period. The spread is almost back to "normal" levels now. All that is missing is for 30-year fixed rate conforming mortgage yields to fall to 4.5%, but that should follow shortly.

Several things are at work here. On the one hand, yields are unbelievably low in general because the market is convinced that deflation is going to be with us for many years. On the other hand you have the Fed, which is promising to keep short-term interest rates close to zero for a long time time; this effectively forces people to move out of cash and into longer-term and riskier investments in order to pick up yield.

And then there is the fact that the Fed is now buying mortgage-backed securities directly (though in such relatively small quantities that I don't think that can explain the bulk of what has happened). Finally, we can't ignore the fact that the demand for mortgage loans must be weak, at least relative to the desire of investors to own mortgage-backed loans.

If anything is going to dispel the deflationary gloom that seems to pervade the market, it's things like this. Refinancing activity is already up significantly, and will likely rise much more. New applications for mortgages are up a bit, but should rise considerably in the months to come.

We have two powerful forces converging—sharply lower mortgage rates and steadily declining home prices—and I don't think the savvy American homebuyer is going to fail to take notice of the arrival of an opportunity of a lifetime. People respond to incentives, and I would be very surprised if we don't see a bottoming in housing prices before summer.

Comments

[vodka_tonic:]

Sir, you make some excellent point, low rates and low home prices....but the problem now is that ALL things are falling really fast in terms of price....one of my barometer's is food....many restaurants that i frequent, especially those catering to the poor, are slashing prices.....oil is already so low....i fear that housing prices are gonna go lower.

Jan 13 04:32 AM

[Mithan:]

Lower? Sure, probably another 20%.

However, when things pick up, it will be quick and strong.

What most economists are missing is that there will also be a HUGE upshot to all of this.

For the last 10 years, a SIGNIFICANT portion of people's income went into a mortgage. Now with homes literaly cratering, it means people buying those homes will have relatively small mortgages when compared to what they had 2 or 3 years ago.

Do you know what kind of extra spending money that puts into people's pockets when they have much smaller mortgages? It will be huge.

Jan 13 05:20 AM

[RSAAKS:]

Strength in housing cannot arrive until prospects for jobs stabilize. Even though unemployment is a lagging indicator, and we probably won't see it in the headlines until after the fact, layoff must end and wages need to stabilize and then housing will begin to recover. In fact all the pent up demand, from people who have been postponing their decision to buy a house, will rush to the market to beat the prices recovery.

Jan 13 08:43 AM

[Alexandre K...:]

Nice article.

I totally agree with User 55065 about the need to stabilize employment and wages before residential investment picks up again, which will lead thereafter to a recovery in home prices and a broader recovery in the economy.

I also think, as the author implicitly emphasized it, that the housing market is the KEY factor for the US economy, as it is the KEY driver for consumption. Once US consumption picks up, the whole world will recover as the US consumer will import goods from China which will buy oil from the arab countries and Russia, and machinery from Germany and Japan, etc...

Jan 13 10:33 AM

[The Good Ne...:]

User 55065 and AlexK

>Strength in housing cannot arrive until prospects for jobs stabilize.

You are right that unemployment rate rise is a lagging indicator. The leading indicator for employment is "new claims." New claim moving average is now negative. This now bode well for jobs stabilization.
See another excellent CBP post on initial claims at:
seekingalpha.com/artic...
Or
mast-economy.blogspot....
For details on what all the top 10 leading indicators are showing now.

Jan 13 06:49 PM

[jepittman:]

The combination of falling home prices and falling mortgage rates is akin to two automobiles approaching each other on a two lane highway. It will not take long for the twain to meet. When a trough is evident in housing investors will 'look over the valley' and see the recovery and shift investments into risk assets.

Jan 13 10:04 PM