VA Home Loan mortgage rates defy expectations

Borrowing levels are lower than one year ago, and dropping

It's a Great Time to get a VA Home Loan

By John P. Allen

Mortgage rates were supposed to be rising by now, helping to gradually cool the nation's red-hot housing market.

The Federal Reserve has been raising short-term interest rates steadily for nearly a year. The economy is growing at a healthy pace. Energy costs are up. If history were a guide, long-term rates would be rising, too.

But they are not. Even Fed Chairman Alan Greenspan has called this a "conundrum."

Defying predictions, U.S. mortgage rates are lower than they were a year ago and are falling. That's a large part of why home sales and prices are at record highs and are fanning worries of a real estate investment bubble.

The rate on the average 30-year fixed-rate mortgage fell to 5.65 percent in the week that ended May 26, the lowest rate since mid-February and below the 6.32 percent level of a year ago, according to mortgage financier Freddie Mac.

"The housing market is going to be robust if rates stay where the are," said Freddie Mac's chief economist, Frank Nothaft. "But it's hard for me to fathom why they would stay this low for long."

While home buyers cheer the bargain borrowing costs, some economists admit to being puzzled and concerned. If mortgage rates keep sliding, they will pump up any bubble. But if rates snap up suddenly, a bubble could pop, with both prices and investment dropping sharply, hurting many borrowers and investors.

Global financial markets, not any government body, determine long-term interest rates through their bond trading each day. High demand for bonds pushes up their price and drives down their yield, yield being their effective interest rate after factoring in their purchase price. A combination of factors keep driving demand and pushing rates down, forces that have "much more to do with speculation, hedging and politics than . . . with actual investment merit," wrote Peter Schiff, president of Euro Pacific Capital Inc., a Newport Beach, Calif., investment firm, in a recent analysis. "Once these forces reverse, expect bond prices to plunge and interest rates to soar."

Mortgage rates are largely determined by the yield on the 10-year Treasury note. Last June, when the Fed's benchmark short-term rate was 1 percent, the 10-year yield was 4.69 percent and the average 30-year mortgage rate was 6.25 percent.

Since then, Fed officials have raised their benchmark federal funds rate, which is charged on overnight loans between banks, to 3 percent and indicated they plan to move it higher to keep inflation in check. But the 10-year yield has fallen below 4 percent, to 3.88 percent yesterday -- the lowest level since March of last year.

Some analysts are now predicting it will keep sliding. Merrill Lynch's interest-rate committee last week lowered its yield forecasts, projecting the 10-year Treasury to yield 3.8 percent by year's end.

Morgan Stanley's chief economist, Stephen S. Roach, on Tuesday predicted that the yield could reach 3.5 percent in the next year. That represented a turnabout for someone who had insisted for months that interest rates would eventually rise as part of a correction of the nation's huge trade deficit.

Economists are now studying the "conundrum" intensely, finding a variety of partial explanations.

Some point to short-term issues. For example, one factor that helped push down yields yesterday was a Fed official who implied in an interview that the central bank would stop raising its benchmark rate after its meeting later this month. Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said during an appearance on cable network CNBC: "We're clearly in the eighth inning of a tightening cycle. . . . We have the ninth inning coming up the end of June," according to a partial transcript by Bloomberg News.

Fed officials are likely to raise the funds rate to 3.25 percent later this month. Wall Street analysts widely predict that the Fed will keep going, lifting the rate to at least 3.75 percent in coming months. If the Fed pauses after the June meeting, other rates may stall as well.
 
Fisher's comments touched off a trading frenzy, increasing the already voracious hunger for long-term Treasuries.

Oil-producing countries, for example, have reaped a profit windfall over the past two years as crude prices rose from around $35 a barrel to above $57 a barrel in early April. Oil trading is denominated in dollars, so many producers have parked their profits for the time being in U.S. Treasuries.

The recent downgrading of debt issued by General Motors Corp. and Ford Motor Co. have prompted some investors to move money from corporate bonds to Treasuries, which are considered extremely safe investments because a U.S. government default is so unlikely.

Meanwhile, many hedge funds and traders have bet wrong on a variety of investments this year -- expecting, for example, that GM debt would rise in value or that long-term interest rates would rise. The resulting turmoil in the markets in recent weeks has caused some investors to seek the "safe haven" of Treasuries, analysts said.

The fall in mortgage rates has also caused portfolio problems for some institutions that own mortgage-backed securities. As a result, they have had to buy more long-term securities, causing rates to fall further, said Michael Decker, senior vice president of research and public policy for the Bond Market Association.

Combined with these short-term factors are long-term economic conditions.

Yields are relatively low throughout the industrial world in large part because the Fed and other central banks cut their short-term rates low in response to the 2001 recession and have held them relatively low since then.

Inflation has also been extremely low in recent years.

By raising short-term rates by two full percentage points in the past year, the Fed has assured most investors that inflation is under control, some analysts said.

Low yields on the 10-year Treasury "reflect the general view that growth in prices will remain benign over the coming decade," Decker said.

Much of the demand comes from a global glut of savings relative to investment opportunities, according to Fed board member Ben S. Bernanke. Asian central banks that have trade surpluses with the United States and have pegged their currencies to the dollar, for example, have vast supplies of dollars that they invest in U.S. assets -- including Treasury securities of different durations.

Meanwhile, pension funds and insurers from all over the world have large amounts of retirement savings to invest on behalf of aging populations. Many such investors want to avoid the risks of the stock market or real estate. In some countries, they have recently come under regulatory pressure to match their long-term liabilities with long-term investments -- prompting a shift to bonds with durations of 10 years or more.

The Bush administration in January proposed legislation to bolster pension fund financing. Many fund managers and investors have already started moving money out of stocks and into long-term government bonds in anticipation of the bill's passage in some form, analysts said.

"We see capital flows coming tsunami-style out of Asian central banks and international pension funds located in Europe, the U.S.A. and Asian centers" said Alessandro Giraudo, chief economist of Tradition Ltd., a brokerage firm based in Paris.

Even with the headwinds pushing rates lower, Freddie Mac still forecasts that mortgage rates will rise slowly this year, with the average 30-year fixed rate reaching about 6 percent by year's end, Nothaft said.

Most of the Wall Street analysts consulted by the Bond Market Association also predict that long-term yields, and mortgage rates, will creep up in the months ahead, Decker said.

"They've been saying that for some time, and it hasn't kicked in," he said.

========================================================

John P. Allen is General Manager of Veterans Today and is a VA Loan Specialist. 

If you have more questions, comments, or would like to get a VA Home Loan, please contact John Allen at 1(951) 543.4137 or email him at gm@veteranstoday.com

-------------------------------------------------------------------------------------------------------