WeeklyBasis 4/9/11: Inflation For Dummies

Rates ended last week up .125%, which is the smallest increment consumer rates can move. So if you call that a roughly flat week, then it’s the sixth week of flat rates. But this rise is the result of an inflationary tone building in markets, and the latest business and consumer inflation data are released next week.

It’s also worth repeating that rates are experiencing gut-wrenching swings of about +/-.25%. Daily swings matter because people enter into real estate transactions and must lock rates daily. When rates move so much each day, the question is: will the upside swings stick? Let’s explore that question.

Consumer mortgage rates rise when mortgage bond prices drop in a selloff. Investors sell bonds on inflationary fears because inflation reduces buying power of the future annual payments an investor receives from a bond.

And inflationary fears are spreading.

Europe and China both hiked rates this week to avert their own inflation pressures. And prices for oil, precious metals, and agriculture are all soaring.

In a busy economic week, this Thursday and Friday are perhaps most important because March producer and consumer price figures will be released, giving markets the latest on U.S. inflation.

Bond traders will be watching these numbers closely, and if they’re higher than expected, rates would rise as bonds sold. The question is just how much bonds would sell.

The answer is that mortgage bonds have the potential to drop 100-110 basis points, which would translate into rates rising about .375% to .5%.

To explain why, we come back to the fact that mortgage bonds have trading been in a relatively flat pattern (despite those big daily swings) for about six weeks. Before that, we have to go back to February 9 to see when rates last spiked on a big bond selloff.

That ‘relatively flat pattern’ of mortgage trading is sometimes referred to by professionals as a floor of support. If mortgages broke below this floor, that’s where there is 100-110 basis points more to fall to hit price lows reached around February 9.

This isn’t to say it’s a foregone conclusion that bonds will plummet and rates will spike. But it’s a probable market factor consumers must explore with their advisors.

And no, there isn’t an Inflation For Dummies book. That’s some second-rate photoshop work by your humble writer.

On top of next week’s inflation data, there’s $66 billion more Treasury supply being auctioned into bond markets next week: $32b 3yr notes Tuesday, $21b in 10yr notes Wednesday, and $13b in 30yr bonds Thursday. More bond supply can also pose downside price pressure on bonds.

CONFORMING RATES ($200,000 to $417,000) 0 POINT
30 Year: 5.0% (5.12% APR)
FHA 30 Year: 4.875% (4.99% APR)
5/1 ARM: 3.625% (3.74% APR)

SUPER-CONFORMING RATES ($417,001 to $729,750 cap by county) 0 POINT
30 Year: 5.25% (5.37% APR)
FHA 30 Year: 4.875% (4.99% APR)
5/1 ARM: 3.75% (3.87% APR)

JUMBO RATES ($729,751 to $2,00,000) 1 POINT
30 Year: 5.5% (5.62% APR)
10/1 ARM: 5% (5.12%)
5/1 ARM: 4.25% (4.37% APR)