In one of the most watched political developments in recent memory is the decision by British voters to leave the European Union.
This “exit” narrowly passed and the EU is still deciding what to do next.
What the impact of Brexit will be both long and short term and how and when Britain will make the Brexit official. Yet even though these events are unfolding across the Atlantic Ocean and the United States certainly doesn’t directly have any official connection with the EU, the decision by Britain to leave the EU is having an impact here. And it means mortgage rates could continue to remain near historic lows.
Let’s first recall the dynamic between stocks and bonds. Investors like to put their funds into stocks when future economic growth is anticipated. When the economy is rolling along and corporate profits rise, stocks rise in tandem.
On the other hand, when the economy appears to be faltering investors will put their funds in the safety net of bonds, including Treasuries, T-Bills, Notes and yes, mortgage bonds.
The rate of return on these bonds, especially in today’s environment, is rather small. Bonds are always that way. The returns can’t compare to the profits garnered from a booming stock market yet bonds don’t lose money. If a publicly traded corporation misses its quarterly target, its stock value will fall and investors will lose money.
Further, if a corporation declares bankruptcy, stockholders lose everything. Bonds cannot go bankrupt nor do they have to report quarterly earnings. Instead, bonds provide safety.
When an investor buys a bond the yield is known upon purchase of the bond. The yield will be relatively small, but it’s better than losing money on Wall Street or any other exchange, including foreign exchanges. The United States is considered the world’s “safe haven” and investors around the globe buy bonds in times of financial uncertainty.
Consider the 10-year Treasury. Just this past week the yield fell to a record low of 1.367%. Because bondholders are guaranteed a specific return, when more investors buy bonds this demand for bonds drives up the price, driving the yield lower.
This lower yield is the lower rate of return. As more and more investors push money into these bonds, bills and treasuries driving up the price, the result is a lower rate of return- the yield.
Higher price, lower rate. Even your mortgage rate and one reason why homeowners have recently returned to the refinance window.
Is The Impact of Brexit on Mortgage Loans a Trend?
When consumers shop around for interest rates from mortgage lenders and ask for a rate quote for a 30 year fixed conforming rate, they’ll soon find that most mortgage companies quote very near the same rate with perhaps the only difference being the associated closing costs. That’s because mortgage lenders set their interest rates each day using the very same set of indices. For example, the corresponding mortgage bond for a 30 year fixed rate is the FNMA-30yr this week had a price of 104.02 as the yield has been on a steady decline for months. And according to Freddie Mac’s weekly mortgage rate survey as of July 7, 2016 the average rate for a 30 year fixed conforming loan was 3.41%, getting closer to the record average low of 3.32% in late November of 2012.
But is Brexit driving this trend?
Probably. In fact, many will tell you it’s definitely causing rates to fall as investors continue to pour money into the safety of bonds. There is some concern that other countries will leave the European Union. The United States has negotiated trade deals with the EU as a whole, which includes Germany, France, Spain and other important countries the United States considers a trading partner.
Trade agreements have been established with the EU, not with individual members of the EU. Should the EU fall apart, trade agreements will have to be renegotiated and on a smaller scale.
In addition, should consumers here begin to see the effects on Wall Street and begin to think the economy here is heading for troubled waters as a result of Brexit, consumer spending could falter, weakening the economy. That too will boost the price of bonds, driving yields lower still.
Impact Of Brexit On The Dollar
The weakened British pound also means a stronger dollar. While at face value that seems like a good thing and it is if you’re traveling abroad because your dollar buys more today than it would have six months ago. But corporate profits will be hurt because the United Kingdom as well as the European Union will be buying goods exported from the U.S. with deflation rate, making our exports more expensive. It’s easy to see a strong dollar hitting corporate profits.
Earlier in the year our economy has been on a steady rise. Even after the initial impact of the Brexit vote when the Dow shed nearly 1,000 points over a two day period, stocks seem to have recovered. Yet Brexit has kept the Fed on the sidelines. Investors had been expecting the Fed to begin raising rates in anticipation of a growing economy yet the uncertainty regarding Britain and the EU is holding them back from raising anything.
The last rate increase was in December of last year and many investors, including some Fed Board Governors, expected a rate increase at their most recent round of FOMC meetings. That didn’t happen. In fact, the Fed signaled while it might still increase rates this year it might only be one time, if then. Six of the 17 Board Members felt there would only be one increase in 2016. This signals an uncertain economic future.
This uncertainty will continue to drive rates lower and that includes your mortgage rate as mortgage bonds continue to benefit from investor dollars.
Will rates fall below the record hit in November of 2012?
It’s possible but no one can tell with any certainty. However, if the EU does in fact lose another member and join Britain with its own exit, we just might.
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