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Why Are Interest Rates Going Down?

Putting Money on MBSs

For months the alleged experts (including me) espoused the logic that after the Fed exited the Mortgage Backed Securities Purchase Program on March 31, interest rates would move up.  But here we sit, 60 days later, and rates are at their lowest point of the year.  What’s up with that?

Let’s start with some general economic realities.  First, there is a finite amount of cash in the world.  Second, there are only four basic places to put that cash:

  1. In the stock market.
  2. In the real estate market, which includes the financing of real estate (Mortgage Backed Securities).
  3. In the Commodities Market (gold, silver, orange juice, pork bellies, etc).
  4. Or leave it in cash (CDs, money markets, etc).

Cash itself has a near zero rate of return.  Rates on CDs barely outpace inflation.  Commodities are mostly an unknown for the average investor.  So, for the most part, we look at cash moving back and forth from Stocks to Bonds (MBSs) and vice versa.

When the stock market is moving up, investors buy stocks with their cash, which means the cash leaves the bond market.  To attract buyers back to bonds, the bond traders have to offer bonds with higher yields (that is loans with higher interest rates).

When the stock market is trending lower, you hear the expression “flight to quality” towards the safety and stability of bonds.  When more people look to buy bonds, bond traders lower the yields (hence lower rates).

How does this relate today?  Look at the failing economies in Europe and Greece.  Investors are nervous about the impact on our stock market as international partners struggle.  The Dow has dropped nearly 2000 points!  So people are pulling their cash out and buying MBSs at a feverish rate… therefore, lower rates.

Will it last?

Many stock analysts are predicting a rebound beginning in July.  That seems to make sense for me and that is great news for all those homebuyers who need to close by June 30th to get their Tax Credit.  It also is helping all those sellers who went to Contract in April and are house hunting in May!

We are back into a more traditional interest rate forecasting model.  Watch stocks, watch inflation and watch jobs numbers, and you will make wiser decisions.

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