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The Secondary Market Overview: From Bonds to Production ... Why Did They Go Up?

Dave Hershman
Mar 07, 2011

Why did they go up? There have been two important messages delivered on a consistent basis from this column. First, no one can predict the future, and second, you must be prepared for the future. An expert is not in position to predict the future. An expert is in position to know what could affect the future. An expert is also prepared for what could happen in the future. Last month, I discussed the need to be prepared for the transition from a refinance to a purchase market. I certainly was not predicting that rates would go up immediately. However, it did happen. The next question is … why why did it happen? I asked our resident secondary technical expert, Eric Holloman of RateLink and here is what he had to offer … “Rates came under a double whammy following the announcement from the Fed where they published the amount of bonds they intended to buy. There is a saying on the ‘Street,’ buy the rumor, sell the news. Rates fell following Ben Bernanke’s hint at further quantitative easing. That sparked a firestorm on Wall Street on how much the Fed would buy. Remember QE1 was a whopping $1.75 trillion, including $1.25 trillion in mortgage-backed securities (MBS) and $500 billion in Treasuries? Some market ‘experts’ were forecasting the number as high at $2 trillion for the second quarter The $600 billion was in the middle of what the Street was expecting. Rates came under pressure following the announcement because the Fed's number was not ‘shocking.’ Adding to the pressure on rates is the VERY REAL concern that QE2 may spark inflation, the number one enemy to rates. The inflation concern in very real, even within the Fed. Several Fed districts dissented (voted no) on further easing citing inflation as the reason for their dissent.” Eric makes some great points. I would add that most of the experts were saying that rates would stay low and you should always bet against the experts. That sounds good and many times this is a good bet; however, it does not give us a substantive reason as to why the experts are wrong. It does explain why I refuse to predict the future. It did look as though rates were staying low, especially with the economy faltering, the addition of the foreclosure crisis to an already weak real estate market and the Federal Reserve announcing a plan to start purchasing up to $600 billion in assets in order to keep rates down. The stage was set for low rates as far as the eye could see. Don’t get me wrong. I don’t think that rates are high right now, but why did they rise so quickly? The rate spike is a reminder that the all-important powerful government cannot control as much as it would like. For example, the Federal Reserve Board cannot control rates. Yes, it can control short-term rates, but it cannot control long-term rates. We may have forgotten this important fact in the past few years because the Fed's plan to purchase mortgages and Treasuries worked so well as the financial crisis peaked. However, the key was that the Fed was purchasing these instruments while the economy was in shambles. The markets accepted the move. The markets do not seem to be as accepting of the Fed's plan to purchase another $600 billion in assets over the coming months with many concerned that this stimulus could fuel inflation, as Holloman has indicated. It should be noted that this inflation scare came right at the time that the government reported the lowest level of consumer inflation since 1957. The markets are highly psychological, especially in the short-run. That is why you can never predict the future of the stock market and rates. If the market sees a Fed move such as lowering short-term rates or purchasing assets as inflationary, long-term rates can rise in reaction. The fact that rates went up sharply was a surprise to many. On the other hand, there was another fundamental reason for this move. Buried in a very busy week in early November was the employment report. It was buried because we had an election that week and the Federal Reserve announcement as well. However, the employment report was very important. While the increase of 150,000-plus private sector jobs was welcome, it certainly was not earth-shattering since we lost more than seven million jobs during the recession. It did represent a small move in the right direction. The weeks following this announcement saw first-time unemployment claims continue to drop as well. We have also indicated previously that employment is key to our economy recovery. The real estate market will not recover without the economy creating jobs. Of course, it is hard for the economy to create jobs when the real estate market is suffering. This “Catch-22” means that we must take tiny steps out of this vicious cycle. Creating more than 150,000 jobs per month is one of these steps. This fundamental, coupled with the skittishness of the markets regarding the Fed plan and inflation could be what contributed to the spike. So where do we go from here? Well, we need the economy to create 150,000-plus jobs per month on a consistent basis. In other words, the number cannot go back below the 100,000 mark and it must move towards 200,000. That is exactly what happened in November, as the economy actually created less than 50,000 jobs. However, let’s take a look back for some perspective. Just over 18 months ago, we were losing more than 500,000 jobs per month. The fact that we consider the creation of 50,000 jobs bad news is actually good news at this point. Of course, we are not out of the woods and this is why rates are not likely to continue to rise indefinitely. If they do, we may never get out of the woods. The foreclosure crisis must be resolved because we must get rid of the shadow inventory. Like the overall recovery, this should take some time. Early reports on holiday retail sales were encouraging. Consumer spending is another key factor in the recovery process. Does it sound like we are rooting for rates to go up? If rates are going up because the economy and real estate markets are recovering, then that is a good thing. But as we emphasized, they cannot rise too fast without jeopardizing the recovery. Will rates remain at this level or go back down somewhat? Again, you cannot predict the future. What if Korea breaks out in an all-out war? What if the European debt crisis gets worse? These are factors that theoretically could bring rates back down in a flight to safety. One event could cause everything to go out the window with regard to the fundamentals. We may have already have seen some movement from the time I write this column until the time it is published. For now, the fundamentals have not changed that much. There is no inflation. The economy is still very slow and will slow further temporarily due to the foreclosure crisis. Of course, the reminder we received last month of what can happen to rates in an instant should be taken seriously for those who are waiting to purchase a house or a car and think they can wait because they believe rates will remain low forever. Blink an eye and the world can change. That goes for loan officers as well. Go back to my message regarding the transition to a purchase market. If you are not getting ready for this transition at some time in 2011, then you will be left behind. It will be too late to make the transition after it already happens … and November was a month which reminded us of how just quickly it can happen. Dave Hershman is a leading author for the mortgage industry with eight books and several hundred articles to his credit. He is also head of OriginationPro Mortgage School and a top industry speaker. Dave’s NewsletterPro Marketing System can be found at www.webinars.originationpro.com. If you would like to stay ahead of what is happening in the markets, visit ratelink.originationpro.com for a free trial or e-mail success@hershmangroup.com.
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