Interest Rates the Week of 3/22 - 3/26

What a week. We head into Friday having survived a rough week yet we are black and blue for sure. Rates to a real hit this week and it all began Wednesday morning. You can't say that this came out of the blue, yet a downgrade of Portugul's debt by Moody's & Fitch from AAA to AA- caused bond traders around the globe to look at their own portfolios and the debt of other countries. And that meant looking at home at the US---the notion of "maybe USA's debt is not so secure after all---look what just happened in Europe with Portugal and the issues Greece has had for the past several weeks." This spooked traders into unloading massive amounts of their bond portfolio and caused prices to drop significantly.

Another factor causing prices to drop: we have had another massive amount of Treasury debt being auctioned off this week (2,5 & 7 year treasury notes). When you have a set amount of investors and buyers of bonds in the market each week coupled with an additional supply of bonds brought to market to sell (over and additional 100 billion dollars worth), you have over-saturation in the market...and less dollars can go around and purchase this additional debt.

They key here...when bond prices drop we see interest rates go up to attract new buyers. Think about it a bit, I'll take you back to high school and your economics class when you went over Supply vs Demand. If you have an over supply of a product then prices could drop to increase the demand for the product. And this is what happens with bonds. The investors of the world are saying to the US and other countries, "If you want us to buy your debt...pay us more money." And when a country's debt has a yield (rate) increase...it can affect other investments---like mortgage rates!

In the case of mortgage backed securities (MBS), or what I call the investment vehicle that drives mortgage interest rates, we see the yield of MBS trade above the yield of the 10-year treasury note. US debt is and has been a safe haven for investors...we have repaid our debt plus interest for years. It's a safe investment. MBS is an investment that carry's some more risk. Would you rather invest in a 10-year US Treasury debt yielding 3.91% as of 3/25/10 or a MBS yielding 4.5% or 5% as you can openly purchase today. Well, that is an answer for bond traders. They know if they are willing to invest in "Joe American Homeowner" who repays their mortgage 95% of the time or more then maybe that 5% of not receiving the payment is worth an additional .6% to 1.1% in yield to them. It's risk vs reqard. But this additional risk...the chance that a home loan will not be repaid is why there is a premium to this investment type.

To bring it home for you...when US Debt gets over-sold then Treasury Yields go up as referenced by the link in the above paragraph (3.6 yield on a 10-year on March 1st vs 3.91% today). This happens because the FED is trying to attract new buyers of their debt. MBS yields in turn need to keep pace, or stay ahead of a 10-year yield to attract new buyers. If it didn't, no one would buy MBS...they would buy treasuries as it is a safer investment knowing the US will repay that debt. In summary, the over-supply of US Debt and a downgrade of debt over-seas caused bond traders to either seek other investments or require a higher yield to invest in those bonds...and this caused mortgage rates to go up .25% in one day.