KA-BOOM! Holiday fireworks started early for Mortgage Bonds as they rocketed higher for most of last week. What happened to cause all this excitement? A few different headlines…let’s take a look at the news of the week. First, in a surprise move, the United States transferred political authority to an interim Iraqi government in a five-minute ceremony on Monday morning. The transfer of power was conducted two days before the planned June 30th handover date because of major security concerns. Bonds were pressured lower on this good news, but not for long.

Wednesday brought the long-anticipated Fed Funds Rate increase, the first in over four years. Greenspan and friends decided to make a 25bp hike to take action against the threat of inflation. Because inflation hurts a Bond’s value, the Bond market got happy on the news and surged higher. For a great explanation of this relationship between Fed rate hikes and home loan rate improvement, see below for an excerpt from my June 14th issue of the MMG Weekly.

The next big headline came on Friday, with a much worse than anticipated Jobs Report. 112,000 new jobs were created, while Wall Street had been expecting about 250,000 new jobs. The weak release ends a powerful three-month streak of reports that exceeded expectations, and Bonds took another leap higher. Further pushing Bonds higher on Friday was a "flight to quality" bid as we headed into a very pro-American holiday...Independence Day. Overall, home loan rates improved by about .25% throughout last week.

SO WHAT NEXT? After this recent strong rally, Mortgage Bonds may be due for a pullback. In the past, Bonds have moved lower after a holiday weekend that did not involve terrorist activity. As of this writing, we continue to hope and pray that the weekend remains peaceful.

On a technical level, the chart below shows how Bonds are trading just under a formidable ceiling of resistance at their 100 and 200-day Moving Averages, which would be tough to blast through after such a strong rally.

The economic calendar provides little ammo for trading this week, with the only releases of note being the ISM Services Index on Tuesday and Initial Jobless Claims on Thursday. Traders will likely pull some profits off the table and take a breather after all of last week’s action. In the absence of any big surprises, home loan rates will likely trend back upwards slightly throughout the coming week.

Excerpt from the June 14th issue of Mortgage Market Guide Weekly:

JUST LIKE AN EPISODE OF “RIPLEY’S BELIEVE IT OR NOT”…THE FED RATE HIKE ON JUNE 30TH COULD ACTUALLY HELP LOWER RATES ON HOME LOANS.

Strange, but true…When the Fed has lowered the Fed Funds Rate in the past, interest rates on mortgages have actually worsened. So it should be no surprise that when the Fed raises rates the Fed Funds Rate at the end of this month, that a bit of an improvement on home loan rates is expected.

But how does this work and why? Although it may seem counter-intuitive at first, it really does make perfect sense.

First, put yourself in the position of a mortgage bondholder…like the mortgage lender. If you lend the money, you receive interest over time. If that were a mortgage, it could be a full 30 years worth of repayments and interest. Let’s say you were going to be receiving $1,000 per month for the entire 30-year term. At first, that $1,000 may be a very fair return, as you calculate what you can do with that money every month. But over time, inflation requires that you spend more money to purchase the very same goods and services that you can purchase today for less. That same $1,000 just doesn’t go as far in future years as it does today. This eats away at the value of a long-term fixed instrument like a bond or a mortgage, and explains why inflation is the main enemy of bonds. Because bond investors are very aware of this, they will require a higher rate of return or interest on their investment to compensate them, if they feel that inflation will be increasing.

In today’s improving economic environment, inflation is expected to be on the rise. In response, interest rates on long-term bonds, like mortgages, have moved markedly higher in expectation of this. Interestingly, the increase in rates on home loans has occurred without any movement by the Fed, and some mistakenly think that this is anticipation of a Fed rate hike. Not true. Reality is that bond rates are simply pricing in the expectation of higher inflation over time.

Now think about it - a move to tighten or hike rates by the Fed is designed to slow inflation, and we can now see why tempering inflation is very good news for bond holders or mortgage lenders. With inflation reduced, the buying power of their future returns will face less erosion from the effects of inflation.

So believe it or not, this is why a Fed rate hike can actually help reduce rates on home loans.

As your Trusted Advisor, I sincerely hope you have been enjoying your complimentary subscription to the MORTGAGE MARKET GUIDE WEEKLY. As the Independence Day holiday is being observed this week, your next full issue will arrive "hot off the press" on Monday, July 12th.

The MORTGAGE MARKET GUIDE WEEKLY is the industry's leading publication of this type, and I am pleased to provide this valuable resource to you. If you feel any of your clients or associates would benefit from keeping up-to-date on market and economic trends in this easy to read format, please let me know, and I would be more than happy to add them free of charge.

Best wishes to you, and please do not hesitate to contact me if I may be of any assistance to you or your valued clients at this time!