2011 Rate Outlook, Part 1: Rates Crisis Peak To Present

An old lending joke says: the most accurate rate outlook is that rates will go up, down or stay the same. And with market heavy volatility since 2008, this could in fact be the most accurate outlook. But in all seriousness, below we examine these three scenarios since November 2008. This post is PART 1 OF 2 of our 2011 rate outlook. Part 2 is next week, starting where this leaves off.

Rates Will Stay The Same
At the most dire stage of the global market implosion on November 24, 2008, the Fed said they’d buy $500 billion in mortgage bonds beginning January 1, 2009. The goal of this “quantitative easing” (QE) was to bid up mortgage bond prices so bond yields (or rates) would drop to help keep the housing market afloat. 30yr fixed rates were 6.09% back then, and bond investors piled into mortgage bonds ahead of the Fed’s QE start date, causing rates to drop to 5.05% by January 1, 2009. QE ran from then until March 31, 2010 and the Fed ultimately bought $1.25 trillion in mortgage bonds, way more than their original $500b budget. Yet rates were 5.125% on March 31, 2010, almost the same as when QE began on January 1, 2009. Rates dropped to 4.78% three times in 2009 at different trading intervals but rates began and ended QE at the same level.

Rates Will Go Down
Shortly after QE ended, global markets again panicked on May 6, 2010 when Greece had to be bailed out because of its inability to pay its debt obligations. The bailout triggered a debt crisis throughout Europe, causing global investors to sell European bonds en masse and reinvest proceeds into U.S. mortgage (and Treasury) bonds. So mortgage bond prices rose on this massive buying and 30yr fixed rates fell to 4.78% by mid-May 2010. Between mid-May 2010 and September 30, 2010 the U.S. economy posted three months of weaker GDP, home sales and consumer sentiment, fueling further mortgage bond rallies. As a result, 30yr fixed rates fell to a new record low of 4.27%. Then an October 1, 2010 speech by the head of the New York Fed caused mortgage bonds to rally even more on speculation about a second round of QE (QE2), and rates dropped to 4% on October 7-8.

Rates Will Go Up
On November 3, 2010 the Fed confirmed QE2 saying they’d buy $600b in Treasury securities from that date until June 30, 2011. Buying Treasuries helps business and some consumer rates but has no direct impact on mortgage rates like buying mortgage bonds does. Knowing this, mortgage bond investors have been selling since the QE2 announcement, and when mortgage bond prices drop in a selloff, rates rise. 30yr fixed mortgages are 4.875% as of today. We can expect a similar trend going forward because the goal of QE2 is to spur economic growth. When growth eventually leads to signs of inflation, mortgage bonds will sell off further causing rates to rise. The U.S. economy still has 14.5m (or 9.4%) unemployed people plus another 8.9m who’ve been forced into part time work. So we won’t see economic growth (and mortgage rates) spike immediately, but rates will most likely rise from current levels between now and June 30, 2011.