Low Inflation and Strong Auctions

While mortgage rates climbed in December, they have decreased during the first two weeks of January. A combination of factors was favorable for mortgage markets this week. Low inflation, weaker than expected economic growth data, and strong demand for the Treasury auctions all helped mortgage rates move a little lower.
One primary long-term concern for mortgage investors is that the enormous level of stimulus intended to boost the economy will lead to higher inflation. Inflation erodes the value of fixed income investments, so future inflation expectations are a major determinant of bond values, including mortgage-backed securities (MBS). Inflation has not been a factor in the short-term, however, as virtually all of the data in recent months has shown it to be low. This week, the Consumer Price Index (CPI), the most widely watched inflation indicator, showed that core inflation rose only 1.8% from one year ago. The Fed's comfort zone is for core inflation to rise at a 1.0% to 2.0% annual rate, and Fed forecasts are for low core inflation this year. Mortgage investors will be watching these levels closely, and any surprises down the road could push mortgage rates higher. A second major long-term issue for mortgage investors is that the vast increase in the supply of government debt will exceed the demand. So far, both foreign and domestic demand has remained strong. This week's Treasury auctions saw very solid demand, particularly for the longer-term 10-yr and 30-yr securities, which are the most comparable to MBS. The cause for concern is that some important buyers, including China, have been hinting that they will reduce their Treasury purchases if the US doesn't display more fiscal discipline. If demand were to fall, then yields would need to rise to attract investors, which would not be good for mortgage rates. For more information or for a free mortgage rate quote contact Keith Gillow @ keith@frontstreetmtg.com.