What's oil got to do with it?
Do oil prices effect interest rates?
Yes, sometimes. But not always. This year we've seen about a 33 percent correlation.
Oil prices are in the news this week as investors prepare for the International Energy Forum in Algiers later this month. Members of OPEC (Organization of Petroleum Exporting Countries) and representatives from Russia are expected to hold talks about a possible production freeze during the event. However, many analysts expect very little agreement, especially since Iran signaled this week it has no plans to slow production.
Before we get into what this all means for mortgage rates, some background is needed. In recent years the demand for oil has slowed as global economies have in many cases stalled. At the same time, oil production in the U.S. has increased, adding more supply to the market. What happens with more supply than demand? Prices fall. It's one reason we've all enjoyed lower gas prices at the pump for two years.
Rather than slow production to boost prices, OPEC and Russia (one of the world's largest oil exporters) have continued at near-record production levels. That strategy has achieved one goal: It hurt U.S. oil production, which is heavily dependent on the more expensive fracking drilling method. However, demand hasn't picked up and the lengthy oil slump has severely hurt the economies of oil exporting countries. Venezuela, for example, is suffering and citizens are rioting.
For those reasons, many investors expect oil production cuts will be on the table at some point. Saudi Arabia and Russia this week agreed to work together to stabilize the market — those two working together is a sign of how tough times have become. But there's still doubt any production cuts will take place.
“Implementation remains highly questionable and current OPEC production already approaches levels we had not anticipated until 2018,” Macquarie Research analysts said in a note this week.
"There was nothing in Monday's announcement to change our view that oil prices will finish the year a little lower than they are now,” Tom Pugh, a Capital Economics commodities economist, wrote in a note to clients.
So what about mortgage rates? The last several months we've seen the price of crude oil move much more in line with interest rates. Why? The lack of economic strength in oil producing countries.
Low oil prices are harmful to oil-producing countries such as Venezuela, Russia and much of the Middle East. As their economies have suffered from cheap oil, global investors have moved money to bonds in stronger economies, such as the United States.
When investors look for safe havens, more dollars move into US Treasurys. Prices rise and yields fall. Mortgage rates tend to follow the yield on the 10-Year Treasury. Therefore, cheap oil = weak oil economies = buy U.S. Treasurys = lower mortgage rates.
Oil prices are certainly not always an accurate gauge on rates. However, understanding the dynamic should shed some light on the relationship as it stands today. It also shows interest rates face little upward pressure from oil this year.
Overall, mortgage rates dipped just slightly this week, with Freddie Mac reporting the national average for 30-year fixed rates dropping two basis points. We remain in a good market for refinancing, and the data supports the notion, with more than 60% of mortgage activity nationwide being refinance, according to Freddie Mac.
Finally, one more quick take on rates. Goldman Sachs this week told clients it expects the Federal Reserve will try to avoid any surprises between now and the presidential election in November. In a note to clients, Alec Phillips, U.S. Political Economist in Global Investment Research at Goldman Sachs, wrote to clients that a rate hike is a 40 percent probability at the Fed's Open Market Committee meeting in September and just 30 percent in December.
