The Trump administration's talk of tax cuts, along with welcome news from the French election, sent stocks into a frenzy this week, showcasing yet again the close link between political happenings and financial markets.

As we covered in last week's blog, France was on the verge of a hotly contested presidential election that saw National Front Leader Marine Le Pen survive to face independent candidate Emmanuel Macron in a runoff Macron is expected to win easily. Macron, a political newcomer whose pro-Europe, migrant-tolerant posture paints a stark contrast to Le Pen's anti-establishment, anti-immigration stance.

Sunday's results propelled stocks in both Europe and the United States. By Monday, the Dow Jones Industrial Average rallied  more than 200 points, and the Nasdaq climbed above 6,000 for the first time ever. The S&P 500 went up by 1 percent while Treasuries fell and volatility gauges went way down.

The election results encouraged investors who worried that a matchup between extremists on the right and left would create a ripple effect through the eurozone on par with the shakeup already caused by last year's Brexit.

But now that Le Pen faces Macron, a former investment banker and economy minister whose platform is more centrist than his opponent's, investors feel a little more optimistic about France's future. That optimism fueled market rallies around the world that cooled interest in U.S. Treasury bonds.

Tax plan calms expectations

In the U.S., investors began the week with gusto as President Donald Trump unveiled a plan for tax reform that proposed massive cuts to individual and corporate tax rates — all to fulfill a campaign promise that he'd work to spur economic growth and boost the middle class.

Those proposed cuts include slashing the top tax rate for U.S. businesses from 35 percent to 15 percent; reducing the number of income tax brackets from seven to three, thereby easing the tax burden on most Americans; and introducing a one-time tax on overseas profits generated by U.S. multinational corporations. Also in the plan is a proposal to preserve the home mortgage interest deduction but double the standard deduction on tax returns (we'll talk about this more later).

The White House did not include a border adjustment tax, a measure to tax imports from certain countries that had been championed by House Republicans.

Before the plan's release, Treasury Secretary Steve Mnuchin touted the cuts as the biggest in the country's history. Such anticipation excited investors, who anxiously awaited confirmation of lower corporate taxes, and stocks soared in Tuesday's trading.

But, once the plan was actually released, investor expectations were tempered by a lack of details. Trump's team has said the lack of details are by design, with Budget Director Mick Mulvaney telling CNBC Thursday that the plan is a first step early in the negotiation with Congress.

Making moves on the mortgage deduction

For mortgage professionals, perhaps the most relevant piece of Trump's tax plan is the proposal for the mortgage interest deduction and what that means for the housing market.

The White House proposes to preserve the current deduction, which allows taxpayers to deduct interest paid on their homes. This enables homeowners to lower their taxable income, making it easier to afford the cost of their home. But individuals only reap the benefits of this deduction if they itemize. If they don't, they choose the standard deduction, which was $6,300 last year.

Trump's plan suggests doubling the standard deduction, which would make the mortgage interest deduction less feasible for many first-time buyers and low-income families. The National Association of Realtors released a statement Wednesday afternoon calling the plan's intentions good but criticizing it for risking tax benefits that make homeownership less of a financial burden.

"As it stands, homeowners already pay between 80 and 90 percent of U.S. federal income tax," NAR President William Brown said in a statement. "Without tax incentives for homeownership, those numbers could rise even further. And while we appreciate the administration's stated commitment to protecting homeownership, this plan does anything but."

What does this mean for us?

It behooves any mortgage professional to keep their eyes on the White House, especially as it discloses more of its tax plan and makes other policy decisions that directly affect our business. Would-be buyers, especially, will be on the lookout for how the president's policies impact their dreams of homeownership, and how the industry responds in the wake of his decisions.

The past week's political news, from Paris to Washington, illustrates just how much political winds can affect financial markets, and ultimately, the cost of homeownership.

Understanding MBS

In our MBS primer this week, I'd like to cover a few more basics of the mortgage-backed securities market. In past blogs we've discussed the definition of MBS, guarantee rates and servicing fees. Let's look at the yield, risks and pricing basics of MBS.

An investor's yield on MBS is generally calculated as the rate of return on an investment over a given time, expressed as an annual percentage rate.

The feature that most distinctly differentiates a mortgage investment from a traditional bond is the principal repayment method. Whereas a traditional bond typically repays the entire principal amount at maturity, an MBS repays principal throughout the life of the investment. The timing and rate at which principal repayment occurs are major factors affecting an MBS yield. An earlier than expected return of principal generally increases the yield on securities purchased at a discount. However, when an MBS is purchased at a premium, an earlier than expected return of principal reduces yield.

MBS may offer certain advantages, such as attractive yields, to investors but it is not possible to forecast with certainty the actual returns over time on most MBS because of the relationship between interest rates and prepayments. External factors can push interest rates up or down and spark or kill waves of refinancing. This can be difficult to predict with any certainty, making MBS investors at risk of a sudden change in prepayment forecasts.

In addition to this prepayment risk of a borrower retiring the debt ahead of schedule, MBS investors also face market and credit risks.

Prepayment risk and market risk are closely intertwined. The price of any bond, including MBS, is a function of several factors, including interest rates. Interest rate movements have a greater impact on MBS than traditional fixed income investments because they affect prepayment rates that, and in turn, affect the average life and yield of MBS as well as returns from reinvesting principal.

Credit risk is the risk that the investor may not receive all or part of the principal invested because the borrower of the underlying mortgage loan defaulted on its financial obligations. Fannie Mae and Freddie Mac MBS have reduced credit risk because they carry a guarantee of timely payment of both principal and interest, while FHA, VA and other government programs through Ginnie Mae have even less credit risk because their guarantee of timely payment is backed by the full faith and credit of the U.S. government.

Another MBS basic to understand is the cash-flow of an MBS investment, which can fluctuate just like the yield. The cash flow of an MBS consists of scheduled principal payments, accrued interest payments, and unscheduled payments of all or part of the outstanding principal (prepayments).

However, the mortgage investor faces the possibility that the mortgages backing the MBS will prepay more slowly or more quickly than anticipated. Prepayments may occur at any time and for any of several reasons, including refinancing the mortgage or proceeds from the sale of the home. Major investment firms are constantly reviewing their models used to project how cash flow will be affected by these forces.

All of these factors play a role in MBS pricing. The price of an MBS is determined by several factors:

•      Type of mortgage backing the security
•      Level of market interest rates
•      Coupon rate on the security
•      Liquidity
•      Prepayment assumptions
•      Overall demand for MBS

It's important to understand all these complexities of the mortgage industry to fully grasp how loans are packaged and priced. Next week, I'll conclude the series by explaining how these MBS factors all add up to the price of an individual mortgage loan.