How The Dollar’s Value Impacts Mortgage Rates

One can write several volumes about how movements in the dollar impact mortgage lending, and our economy in general. The value of the dollar is widely tracked. For example, the New York Federal Reserve reported that the U.S. monetary authorities did not intervene in the foreign exchange markets during the July-September quarter. But during that period the dollar depreciated 10% against the euro, 5% against the Japanese yen, and its trade-weighted exchange value declined about 7%. So what? Well, a country that cuts interest rates makes its currency less attractive to the world’s fixed-income investors, and money is moved to countries that pay a higher yield on investments.

The quantitative easing program (QE2) pumps dollars into the economy, critics say by merely printing money, and the increased supply weakens the value of the dollar relative to other currencies. Over 50% of our US debt is held outside the United States. When foreign investors sell US securities, they must convert the US dollars they receive into their own currency. If the value of the dollar falls, then the value of their US investment falls in relative terms to their currency. As a result, as the dollar drops foreign investors may reduce their purchases of US securities, including mortgage-backed securities (MBS), which would cause yields to increase. This fear of weaker foreign demand hurt mortgage rates.

But unfortunately it is not that simple. Recently China’s rate hike was another negative for US mortgage rates. Yields must rise in other markets to compete with higher yields in Chinese markets. But then the recent troubles in Ireland caused the typical “flight to quality” and increased the purchases of fixed income US securities – including mortgage-backed securities. If the Chinese currency (yuan) is being valued too low, it makes their exports cheaper and more competitive world-wide. QE2 is designed to increase the demand for Treasury securities and therefore to hold down interest rates and stimulate the economy, which impacts the value of the dollar – but the currency value of many developing countries has skyrocketed during this recent time period. And the dollar index raising has also caused interest rates to rise in line.

But the country that has the most inflation ends up with the weakest currency, the strongest exports and the best performing risk assets. A drop in the dollar can help US companies sell their products overseas, but makes imports more expensive. One could almost make a bumper sticker that said, “No country has ever deflated their way to prosperity!”