Friday, January 11, 2008

What will happen to jumbo loan rates in 08?

Broadly, jumbo loan mortgage rates fell in 2007. It's befuddling because there are two major reasons why mortgage rates should have increased in 2007:
The U.S. dollar took a precipitous decline against world currencies, devaluing mortgage bonds
Inflation ran beyond the top of the Fed's comfort zone for most of the year, devaluing mortgage bonds
When mortgage bonds get devalued, there should be less demand for them. But that wasn't the case. If mortgage rates are lower now than they were a year ago, it means that demand for mortgage bonds must be higher.
There is an inverse relationship between the demand for mortgage bonds and mortgage rates. As demand increases, mortgage rates fall. As demand wanes, mortgage rates increase.
So, in 2007, mortgage rates fell because global investors' desire to hold U.S. mortgage bonds outweighed their desire to sell them -- despite the constant drag against their value.
We can hypothesize that mortgage rates would have fallen much, much more had the dollar been stronger, or inflationary pressures been weaker.
One way to envision this is to think of a runner with a parachute apparatus attached to his back.
The athlete is moving forward but the parachute is adding a tremendous amount of drag. Once the parachute detaches, the athlete picks up a lot of speed.
In this sense, a stronger dollar or weaker inflation could dramatically drop mortgage rates in 2008. It would be like cutting the parachute loose and letting mortgage markets run at full-speed.
The U.S. dollar is another hot spot. A weaker dollar should discourage foreign investment in mortgage bonds. In this sense, the U.S. dollar represents the parachute and the weaker it gets, the larger the canopy.
The "Recession versus Inflation" should be a hot topic through June 2008.
With every sign that recession is winning, expect mortgage rates to fall. When inflation grabs the lead, expect mortgage rates to rise. And watch out for world events that can change the landscape in an instant.