Mortgage Rates to Improve in Uncharted Waters?, August 8, 2011

This is a Monday morning unlike any before.  We awoke this morning to a US nation that is no longer (universally) considered a AAA credit risk.  Following Friday evening’s downgrade of US debt by ratings firm S&P we find ourselves in an environment that is foreign to analysts and economic forecasters.  From early indications in Asia, Europe and in US Equity Futures trading the stock market is likely to fall significantly this morning.  The impact on current mortgage rates, though, is harder to predict.  Home purchasers and refinancers should not make a move without careful attention to the financial news as volatility is likely to be high today.

In a normal market a major stock decline would result in an opposite reaction—a rally in mortgage-backed securities (MBS).  Thus far this morning it appears that MBS are improving (leading to lower mortgage pricing), but not as much as might be expected given the potential stock selloff.  Why is this?  Well the truth is no one can be sure how the markets will treat MBS debt given the credit downgrade.  Some observers believe that MBS could serve as an alternative AAA investment to the now AA+ US Treasury securities.  However, other analysts expect the value of all dollar denominated assets to decline as the US dollar is simply not worth as much.

While all this is going on in the US another, potentially equal crisis is taking place in Europe.  The debt of small European countries has been questioned for a couple of years as their economies simply don’t have the growth to support their level of debt.  Last week this debt crisis spread in a much more serious way to larger nations Italy and Spain sending borrowing costs soaring.  Since the Euro Zone is not a single country, the question for the markets is will the countries with growing economies (France, Germany), back the debt of these weaker partners?  On Sunday the European Central bank announced that it would begin buying Italian and Spanish bonds on the market in an effort to stabilize the crisis and support lower borrowing costs for these nations.  Germany is the primary financial underwriter of this program.  How long will the citizens of Germany be willing to co-sign the loans for their financially irresponsible neighbors?

No economic data today.  Tomorrow is a key meeting of the Federal Reserve’s Open Market Committee.  With the US economy slowing and some say heading toward recession, what will the Fed say or do?  Normally mortgage rates tend to improve in times of economic weakness, but these are not  normal times.