Unexpected news can have a massive impact on the bond market, and thus mortgage rates. Since mortgage rates are a function of demand for originations, typically through the mortgage-backed security (MBS) market, the news can have a tangible impact on that demand by investors.
Over time, market participants have come to expect certain relationships between economic news and asset prices. It should be noted that much of what the news shows is important to gauging the economy, but in terms of market response, expectations of what the figure should be versus what it actually registered are also crucial.
In this blog, we will explore the reasons for mortgage rate movements behind the different headlines we see in the market and address how different types of news can affect the secondary market.
Understanding how news influences demand and drives the secondary market movements is an important skill that helps lenders to better control their margins.
Table of Contents – How News Affects the Secondary Market
- Secondary Market “News” Defined
- How Economic Releases Impact the Secondary Market
- How Treasury Auctions and MBS Demand Impact the Secondary Market
- How the Federal Reserve Impacts Mortgage Rates
- How Regulatory Changes Impact MBS Supply
- How Global News Affects the Secondary Market
- How Market Movement Predictions are Formed by Investors
Secondary Market News Defined
Whether it is scheduled economic data prints, moves by the Federal Reserve, mainstream headlines such as the election, or something totally “from out in left field,” each type of news plays its part in bond market movements, which is characteristic of the secondary mortgage market.
Any daily secondary market commentary will reference Treasury yields, as well as some other points like the “MBS basis.” The reason is simple: MBS prices, as well as the prices and yields of nearly every fixed-income security, price (“trade”) off a spread to the risk-free U.S. Treasury market.
News that impacts Treasury yields will also impact mortgage rates, and therefore the profitability of mortgage lenders. But what drives the sudden changes in Treasury yields and MBS are what can be wrapped up under the general banner of “news.”
In the next sections we will examine different types of “news,” and their sources, along with their impact on MBS prices.
How Economic Releases Impact the Secondary Market
Investors look to economic releases for a barometer on the health of the economy. Generally speaking, when the economy is trending upward, money flows into equity markets and out of the mortgage bond market. This causes prices on Treasuries and MBS to decrease, which puts upward pressure on mortgage rates. The opposite generally holds true when money is flowing into Treasuries and MBS.
Each week, lenders can find data points like the Mortgage Bankers Association (MBA) weekly mortgage applications survey, store sales, or initial jobless claims are released. There are also monthly reports such as the employment data, retail sales, housing starts and building permits, as well as quarterly gauges like GDP.
U.S. government agencies, such as the Federal Reserve and various Fed banks, the U.S. Census Bureau, and the Bureau of Labor Statistics release most of these scheduled economic reports. Private entities like the National Association of Home Builders, Mortgage Bankers Association, or National Federation of Independent Business release their own. The New York Fed publishes the Economic Indicators Calendar each day.
There are a few reports that all generate significant price responses in a systemic manner and then there are all other reports that can move the market. See the two lists below:
Economic Releases that Generate Price Responses
- Nonfarm payroll numbers,
- GDP advance release,
- Consumer and Producer Price indices,
- and private sector manufacturing indices
Economic Releases that Move the Market
- personal income and outlays,
- personal consumption expenditures,
- housing starts,
- and consumer confidence, among others
Lower-tiered economic releases beyond those mentioned
tend to generate little or no significant price responses. Generally speaking, a strengthening economy leads to more positive reports and upward pressure on interest rates. News of stronger-than-expected growth and higher inflation generally creates a rise in bond yields (higher interest rates).
Did You Know?
The significance of scheduled news can change over time. For example, in the 1980s the Federal Reserve would release its money supply numbers every Thursday afternoon.
These figures have all but disappeared, and, currently, the employment data released on the first Friday of every month has become the key indicator with the potential to move interest rates.
Reactions to Treasury Auctions and MBS Demand
Historically, the 10-year U.S. Treasury yield and the 30-year fixed rate for mortgages have trended together, making the 10-year U.S. Treasury yield a closely watched instrument. U.S. Treasury prices are determined by supply and demand for Treasury debt at auction and afterward in the secondary market. The modest return (the 10-year Treasury note has traded under 1% for much of 2020) is offset by the extreme safety of the asset.
The reactions to treasury auctions and, subsequently, Mortgage Backed Securities (MBS) demand, can be summarized in the following statements.
Any unusual moves in the demand for Treasury securities can impact rates. What if no one wanted to buy 30-year Treasury bonds at an auction? That unwelcomed surprise would move interest rates.
All auctions are open to the public, but the major players are:
- the Federal Reserve
- domestic banks
- overseas investors
- and money managers.
Prices move higher with more buyers in the market. Because price and yield have an inverse relationship, anything that increases the demand for long-term Treasury bonds usually puts downward pressure on interest rates.
A weaker economy promotes a “flight to quality,” increasing the overall demand for Treasuries, creating lower yields and lower rates in the secondary market.
That “flight to quality” caused by investors buying fixed-income securities often extends to Agency MBS.
Did You Know?
A “flight to quality,” also know as a “flight-to-safety,” can be observed when investors, as a reaction to market movements, sell what they perceive to be higher-risk investments and purchase safer investments.
The demand for each different security affects what rates mortgage originators offer. Much like Treasury auctions, each day Fannie Mae, Freddie Mac, and Ginnie Mae MBS pools actively trade in the secondary markets and the Agencies auction MBS pools to investors. Prices are based on gross and net supply, factors affecting demand for each, and the additional yield (the positive spread from Treasuries to Agency MBS) due to the additional embedded risk of prepayment or default.
Coupon selection of new MBS securities is determined by best execution, which will hopefully generate the highest profit for the originator. And thus, news educating investors about volumes of certain coupons is relevant. Few want an illiquid coupon in their portfolio. It really is a balancing act. Investors do not want to buy fixed-rate investments when they anticipate rates rising in the near term and potential for higher returns exists. Conversely, in a falling-rate environment, investors can be wary of investments that will be refinanced and paid off early and will watch for news educating them about it.
(The primary/secondary spread is the difference between the primary mortgage rate and the par MBS yield, which widens when rates drop and origination capacity becomes constrained, which helps explain why mortgage rates are sticky relative to observable changes in Treasury or MBS yields.)
Poor demand for Agency securities or auctions means lower prices, higher yields, and higher mortgage interest rates.
While many people believe the Federal Reserve, through the actions of the Federal Open Market Committee, has a direct impact on mortgage rates, it is more so that speeches from Committee members, announcements of what it is doing, and actions in the open market serve as useful predictors of future rate movement.
The impact of the federal reserve on mortgage rates can be summarized in the following statements.
Inflation erodes the return on fixed-income securities, which the Fed will counteract with tighter monetary policy by raising rates, hoping to prevent bonds from selling off too much and rates to moving higher. The Federal Reserve operates under its dual mandate of promoting maximum employment and stable prices for the American people, along with promoting stability of the financial system. Monetary policy and the setting the Fed funds rate are both careful balancing acts by the Fed.
The Fed also conducts purchases of Treasury securities and Agency MBS, keeping prices at a stable and high level, and interest rates down during times of economic hardship. As we saw in the most recent financial crisis, the Fed acted swiftly to address the economic and financial effects of the pandemic. It quickly lowered the target range for the federal funds rate to 0% – 0.25% in order to bolster the economy, took steps intended to stabilize the financial system by updating its guidance, and undertook programs to inject liquidity and promote credit in the economy.
Fed policy has dominated valuations of MBS ever since Fed purchases under QE1 and QE3 made the U.S. Government the largest holder of MBS. At its peak, the Fed owned nearly 1/3 of all Agency MBS, but balance sheet runoff has dropped its holdings to closer to 1/5 of currently outstanding Agency MBS. The markets watch the Fed at the end of its meeting for surprises in the announcement. Every word is combed over compared to the last announcement. Every Fed President speaker makes the news.
The result is that Fed balance sheet policy is the primary driver of MBS spreads, a key determinant of MBS valuations. Whatever way you look at it, news from the Fed is an important driver of MBS pricing and therefore rates for borrowers.
How Regulatory Changes Impact MBS Supply
Any news of GSE reform, changes in departments pertaining to compliance, or changes to issuance have massive implications for the bond market. Not only do Agency changes potentially impact the supply of MBS entering the secondary markets, but the quality of that asset.
The impact on how regulatory changes affects the bond market and, subsequently, MBS supply, can be summarized in the following statements.
Moves by Freddie and Fannie, and Ginnie Mae affect lender’s bottom lines, and many costs are passed on in the form of higher rates or a deteriorated price offered to borrowers. Since 2008, and the Agency conservatorship (leading to ownership by the U.S. taxpayer), increased regulation has led to increased compliance costs. New regulations mean more staff for companies to hire.
News of any change to the structure or organizational chart of the Agencies can impact mortgage rates as investors evaluate their policies, procedures, and safety. The Agencies have been granted the ability to hold onto their profits despite remittances to the Treasury standing well above the original investment. It is being challenged within the court system along with the open-ended conservatorship status whether or not it was legal for the U.S. Treasury to accept profits of the GSEs.
There are other scenarios where regulation impacts mortgage companies. Balance sheet treatment of mortgage servicing rights (e.g. fees charged for servicing the loans), was changed to be much more intensive under Basel III. The result was that MSRs (mortgage servicing rights) were actively sold to non-bank entities which were not subject to Basel rules. News of this impacted the supply and demand of MSRs, thus influencing the price.
Regulatory changes really depend on what type of change is happening. News that the Consumer Finance Protection Bureau was increasing its power base and enforcement action made processes harder for mortgage companies. Mortgage pricing worsened as companies either increased staff or put aside reserves to pay penalties. Mortgage rates rose on a relative basis to compensate. On the opposite end of the spectrum, anything that cuts costs and promotes efficiency will likely lead to lower rates in the form of lower pricing for consumers.
How Global News Affects the Secondary Market
In this last section, we will summarize how global news affects the secondary market.
Events like two countries striking a peace treaty, or an incoming hurricane, are not directly tied to bond markets, but generate price changes in the secondary markets nonetheless. For example, as news unfolded regarding the pandemic in 2020, specifically its impact on the economy, it caused rates to drop.
The underlying thought is that good global news will foster a strong economy and have an upward pressure on interest rates. Bad news engenders the opposite, though it is more likely to create short-term volatility as a result of uncertainty. To a large degree, political headlines have a larger impact on stocks as we have seen in the second half of 2020, but bonds in the secondary market are not immune.
Global news that pertains specifically to the mortgage market can also influence the secondary market. Examples would be updated trends in prepayments, a technology release that provides new efficiencies to the mortgage origination process, or a drop/rise in mortgage interest rates that makes front-page headlines. For example, if news is announced of a new technology that improves the borrower experience, in turn boosting the borrowers’ likelihood of closing, this “good” news could in fact have the opposite effect and push rates down due to the decreased origination costs.
Negative headline news or unexpected bad can promote a “flight to quality.” The opposite is also true, which means mortgage rates are likely to rise when there is good news. (i.e. Brexit talks breaking down, or a country heading toward bankruptcy) news (i.e. a country’s leader dying, an unexplained major plane crash)
How Market Movement Predictions are Formed by Investors
Much of the determination of mortgage prices and movement is from investors’ best guesses as to where the markets may be headed, and this is derived from news. In this section, we’ll discuss how these best guesses are formed and distributed by investors and how you, as a lender, can use this information to your advantage.
The secondary market exists to help facilitate primary mortgage rates offered to borrowers that are closely tethered to the par MBS yield. The relationship between supply and demand is constantly demonstrated in the MBS market as news is released impacting both sides of the equation.
As news is released, investors weigh its impact on interest rates. Capital markets staff sets their rates by calculating the optimal security coupon through capital market pricing, and margins reflect saleable demand for that specific loan, the lender’s competitive position, the required return on the asset which we define as margin need or budget, whether the lender is gaining or losing market share, and the overall production capacity of the company.
There is little room for capital markets people who try to predict the news, or the markets. In fact, sometimes a piece of news that one would think would push rates higher or lower has the opposite effect.
Adjustments in the price of financial assets are a constant as market participants reassess their views of current economic conditions and anticipated future direction, once again driven by pieces of news. Generally, news moves interest rates when it is unexpectedly weak or strong. That assumes that expected news is already priced into the market, and news that is unexpected moves the bonds in the secondary market.
Understand the Impact of News on Your Business
Understanding all the different types of “news” that influences mortgage rates comes with experience, and being able to relay that information to originators is one of the roles of good capital markets staff.
Working with a trusted hedge advisor or loan sale platform is the best way to maximize execution in the secondary market and to reduce risk during market fluctuations.
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