Monday, September 21, 2009

How does the stock market affect mortgage rates?

There’s an old joke in the financial world: Put two economists in a room and you’ll get three opinions. This is always true about the stock market, but the last few weeks have seen an up-tic in speculation as to what the market will actually do. First there was talk of a September Crash. That didn’t happen. Now there’s talk of an October crash as part of a W-shaped recession . I guess time will tell whether or not that happens. But here’s the question my customers want to know: What if the stock market does crash? What will that do to mortgage rates?

Although the stock market does not directly impact mortgage rates, the bond market does. And since there’s a direct relationship between stocks and bonds, stocks have an indirect effect on mortgage rates. How does it work? When stock prices fall, investors pull their money out of the stock market. The big investment firms like Goldman Sachs (these are the guys who really move markets) need somewhere else to put their money. These guys have too much money to just stick under their mattress, so they look to Bonds and Treasuries for a backup plan. These safe havens provide them with a fair yield with minimal risk. On a side note, Southern California based Pimco has always been bullish on Bonds.

From here it’s a simple law of supply and demand. When stock prices fall there’s less demand for the blue chips and money moves into bonds. This increase in traffic towards bonds means that less of a yield is required to satisfy the investor. A lower yield means lower rates for the consumer. When stock prices are on an upward climb, investors move their money back to greener grass. As the money moves back into stocks, the bond market is faced with diminishing demand. The way to re-attract customers is to offer a higher yield. The only way to increase yield is to increase the rates charged to consumers.

This should sound familiar to us. The Dow Jones was on a downward slide starting in 2008 until finally hitting its bottom in March of 2009. At the same time, mortgage rates started falling until finally reaching their low in April & May of 2009. The loans that funded in this record low were actually approved and locked a month earlier. This is when the Dow was at its low, and so was the bond yield. Since March, the stock market has gone up, and so have mortgage rates.

What does the future hold? Let’s be honest: If I had a crystal ball capable of answering that question I’d be out buying a lotto ticket instead of writing this. What I do know is this: Since no one can predict the market with certainty, a proactive strategy will always be more effective than a reactive one. A true mortgage professional will advise both proactive AND reactive strategies to protect you from rising interest rates without shutting the door on more favorable conditions on the horizon. Combining these two disciplines is the best way to ensure: you win!