Rates Improve As Fed Tone Softens

This past week, interest rates held steady and near the best levels in over one month. Let's look at what happened last week and peek into the week ahead.

Treasury Selling More Debt

Last week, the Treasury Department sold over $100 billion worth of Treasuries, to fund the government. The increase in our deficit spending and subsequent debt downgrade during the summer was a reason for the spike higher in interest rates. So, every time there's an auction, markets are on edge as to what the appetite will be to purchase these bonds. If buyers do not have a strong appetite to purchase our debt at current interest rates, the Treasury Department must give higher yields or rates to entice buyers to purchase the bonds. And as treasury rates go higher, so do mortgage rates.

The auction results last week were OK, meaning the Treasury Department was able to sell all the new debt without increasing rates – however, the purchasing demand was less than stellar.

"If the rise in bond yields is sustained, the Fed will have to think about the tightening impact of those credit conditions on economic performance, and would there be dangers of overshooting" - Chicago Fed President Austan Goolsbee.

Fed Officials Soften Tone

A host of Federal Reserve officials were out and about last week. As always, they never speak in unison and say the same thing about monetary policy and economic conditions. However, a common undertone amongst the officials was that higher long-term interest rates have tightened financial conditions and are doing the job of the Fed. For example, with mortgage rates hitting 8% a few weeks ago, housing activity and thus economic activity slowed, thereby removing the need for the Fed to raise rates. As of this moment, the Fed Funds Futures, which prices the probability of Fed rate activity, are pricing in no further rate hikes. This is good news, as the last Fed rate hike was in July and as time passes, the chance of a Fed rate cut increases.

Lower Oil Equals Lower Rates

Oil has dropped to the lowest levels in months, falling beneath $80 per barrel. This, as China and other countries around the globe teeter on the brink of recession. Oil prices move on supply and demand. So as demand slows because economic activity slows, prices go lower. Lower oil prices help lower inflation expectations, which ultimately help long-term bonds like mortgages.

4.50%

The 10-yr Note yield, which ebbs and flows alongside home loan rates, has declined nicely from a recent peak of 5.00%. Watch 4.50% as a floor of yield support which is currently halting any further decline in rates. If the 10-yr Note moves beneath 4.50% that floor will become a ceiling which could help halt an increase in rates.

Bottom line: Long-term interest rates, like mortgages, have improved nicely from the highest levels in the century. The sideways trading action we witnessed this week is a good sign as the markets try to consolidate the fast gains. We may have very well seen the peak and long-term interest rates, but it will not be a straight move to lower rates ahead.