Coronavirus market panic set in last Sunday night in America as non-U.S. markets opened terribly. Chaos continued all last week as bond and lending markets began freezing up.
Lending can’t freeze up because lending is the basis for most business and consumer activity in the global economy.
The Fed stepped in tonight (Sunday March 15) to stem panic before a new market week begins. They took the following actions:
– Cut overnight bank-to-bank and Fed-to-bank lending rates (by 1% each) to zero and .25%, respectively, to enable and encourage banks to keep lending.
– Will buy “at least” $500 billion in Treasury bonds (of all durations) and $200 in mortgage bonds to keep rates low for consumer and business loans.
This helps consumers with low rates on things like mortgages and business loans.
And even more critically, it hopefully keeps banking and lending from freezing up.
Below is a primer on how lending can freeze in a panic, and how the Fed helps prevent this.
We begin with a summary of today’s Fed meltdown prevention actions, and end by exploring if it’ll work.
HOW FED IS HELPING & HOW LOW ARE RATES NOW?
The Fed cut 2 rates today, the overnight bank-to-bank Fed Funds rate, and the Fed-to-bank discount rate.
Neither of these rates impact mortgage rates directly, so mortgage rates won’t be 1% lower next week.
The Fed Funds rate does directly impact home equity line of credit (HELOC) loans. So those will be 1% lower. HELOCs enable homeowners to tap their equity on an as-needed basis.
The Fed Funds Rate and Discount Rate help banks keep lending to you and to businesses.
So we can be confident lending will continue, but what rates will you get on things like mortgages?
Rates are already super low, in the low-3% range for a 30-year mortgage.
Mortgage rates are tied to mortgage bond markets, and rates drop when mortgage bond prices rise on buying.
Rates dropped to current low-3% range in recent weeks as global investors bought mortgage bonds on coronavirus panic.
Bonds are safer than stocks and that’s why investors buy them in a panic.
But now the Fed said they will buy “at least” $700 billion of Treasury and mortgage bonds to help keep mortgage and other longer-term consumer rates low.
Will Fed bond buying cause mortgage rates to drop more?
We don’t know yet.
But we can safely say the Fed’s bond buying will prevent rates from rising meaningfully from here.
Here’s bond and rate market analyst Matt Graham at MBS Live with more on what it’ll do to rates and why the Fed did this:
What will it do to rates?
It will pave the way to a return to or below 3% in the coming weeks.
Why is the Fed doing this?
Look around you. Read the news. Talk to people. There’s a massive, guaranteed, global recession on the horizon. We’ve been waiting for this one and scratching our heads as to the cause. Coronavirus cleared up the doubt as to the cause and the timing. The “waiting” and the stellar all-time highs in stocks seen less than one month ago both set us up for extra momentum and a bigger fall. All the Fed is doing here is trying to soften the blow before it truly lands.
Unfortunately, this may well turn into another instance of markets expressing the notion that Fed money doesn’t cure coronavirus, and with rates at zero and [bond buying] announced, investors will view the Fed as being out of bullets. That could lead to the most staggeringly dramatic volatility we’ve ever seen. Emphasis on “could” over “will.” No one knows exactly what’s going to happen next.
WHAT LED TO FED NEEDING TO STIMULATE MARKETS TODAY?
For context on why the Fed acted on a Sunday, let’s look at what happened in rate markets last week.
Again we go to Matt Graham, who analyzes rate markets in real time for lending and banking pros.
Matt closed out Friday, March 13 with a recap headline saying last week was the wildest week for mortgage rates ever. Here’s an excerpt:
The headline makes a lofty claim, but let’s put doubt to rest with 3 facts right up front.
1. Mortgage rates were at all time lows on Monday Morning for most lenders
2. By Friday, rates had risen as fast as they’ve ever risen in one week
3. By Friday, the gap between mortgages and Treasury yields was the widest on record.
When we have things happening in other markets such as all-time low 10yr Treasury yields (Monday) or the biggest-ever single day loss in stocks (several times, depending on the index), it’s not hard to imagine that big things are happening elsewhere in financial markets.
What’s causing all this? In a word: Coronavirus. The stock market reaction is well-documented, but the record rally in rates is just as impressive.
While coronavirus dominated the headlines, massive drama was unfolding in the mortgage market. All-time low mortgage rates were already in place by March 2nd. Refinance demand was already spiking, but the subsequent jump was the biggest ever recorded.
In financial markets, unprecedented opportunity often comes with unprecedented consequences. In this case, the glut of refi demand was so overwhelming that mortgage lenders couldn’t move loans off their books quick enough to keep up with demand for new loans. The demand could only be created by selling the loans to investors at lower and lower prices.
When investors pay less for mortgages, rates move higher.
Funding issues compounded the problem as some lenders completely exhausted their own sources of financing. In other words, many lenders borrow money with short-term loans in order to originate more mortgages, and many of those wells ran dry this week. Where water remained, there was a steep price to be paid. Lenders’ creditors greatly increased their margins which directly results in higher rates for consumers.
Lower prices from investors… Higher margins from creditors… Underlying momentum toward higher rates after Monday’s bounce at all-time lows… It all added up to the fastest-ever spike in mortgage rates (seriously… and yes, I’m including 1987 in my look-back).
WILL FED’S MELTDOWN PREVENTION WORK?
If last week’s lender funding and capacity problems (Matt discusses above) compound this coming week, lending markets could melt down.
How mortgage lenders fund your loan explains how markets can spiral.
When a mortgage lender funds your loan, they’re rarely using their own funds.
They use a line of credit (aka warehouse line) from a bigger bank, and it goes like this:
– They fund your loan with the warehouse line
– They sell your loan Fannie Mae, Freddie Mac, or another private investor
– Then they pay back the line with interest.
– That frees up the line to make more loans.
– When lending freezes up, warehouse lenders can pull warehouse lines from mortgage lenders.
– Then mortgage lenders can’t make new loans to you, warehouse banks don’t get interest income, and it can spiral.
Markets are very interrelated and the Fed’s job is to “ease hardship that cause disruptions in the economy.”
This is how the Fed worded it on their special Sunday conference call today.
And this should give markets some confidence going into next week.
The rest is day to day, and I’ll keep updating as we go.
Thanks to Matt for his great work as always.
And please let me know if you have questions.