It's not just Donald Trump moving markets
There's good news on its way to your mailbox and email inbox: Your next 401(k) statement.
Equities continue to soar, and it is showing up for more and more Americans as mom and pop investors are returning to the markets. This week we saw the Dow Jones Industrials set a new record high, eclipsing 21,000 points. That's a 15 percent increase since the November elections.
Investors hold a general optimism that President Donald Trump's policies will be good for business. On Tuesday night, speaking to a joint session of Congress, the president laid out an aggressive agenda that included increased defense spending, infrastructure investments, health care reforms, renegotiated trade agreements and regulation rollbacks, among other items. All of those proposals, if enacted, would likely benefit U.S. businesses.
The challenge, of course, will be how the Trump administration plans to pay for its projects. Trump appears to be pinning his hopes on a revved up economy generating more revenue, allowing him to increase spending without cutting popular entitlement programs.
Those issues, plus Trump's tax plans, will be fascinating to watch in the months ahead.
"Trumped" by the Fed
However, there may have been two under-the-radar speeches made this week that will do more to influence mortgage markets in the near future. Two Federal Reserve governors both made strong statements about the prospects of rate hikes at the Fed's Open Market Committee meeting on March 15.
On Tuesday, before Trump's speech, San Francisco Fed President John Williams told an audience he expects a rate hike to be under "serious consideration" at the March meeting. On the same day, New York Fed President William Dudley called the argument for raising rates "a lot more compelling."
In response, yields on U.S. Treasurys surged. The 10-Year yield is currently trading at a yield of 2.50% pushing the high end of the current trading range. As you know, mortgage rates tend to follow the 10-Year Treasury yield and they are headed higher as well.
As a reminder, let's review some basic bond math to help understand the price movement in mortgages relative to the 10 Year Treasury note. All bonds have an underlying mathematical "duration" to help understand the price movement for every basis point in yield. The 10 Year Treasury has a duration of 8.95 and a mortgage-backed security has a duration of 5.06. In other words, a mortgage will move .56% (5.06/8.95) of the 10 Year Treasury. Let's put this into real terms:
If the 10 Year Treasury is up/down five basis points from the previous close the price movement will be .4475 in price. Concurrently, based on the math defined above, you can expect 30-year mortgages to be up/down .25 in price.
To make things easier, in general, 30-year mortgages will move up/down about half as much as the 10 Year Treasury.
Driving the surging bond yields are both Trumponomics and the increased inflation rates. This week, we learned the PCE inflation index jumped 0.4 percent in January, pushing the increase over the last 12 months to 1.9 percent. That matches the highest year-over-year level since October 2012.
With a February jobs report due on March 10, and inflation close to the Fed's 2 percent annual target, the stars are aligning for Fed action. The market now pegs a March rate increase at nearly 89 percent.
As mortgage professionals, we should remember these rate increases are already priced into the market. We've been expecting this, so it's not a surprise. This is an opportunity to confirm for your clients that rates are behaving as expected as the economy continues to expand.
