From HSH Associates January 13, 2006
Thirty-year fixed mortgage rates (FRM) dipped back a little this week, with the overall average losing eight basis points, or .08%, according to the nation’s leading survey of mortgage pricing. Five-one Hybrid ARMs crept upward by three basis points to end the week at an average 5.93%. As short- term interest rates continue to grind higher while longer-term rates hold steady or even decline a little bit, we edge closer to an “inversion” for rates.
Simply put, inversion is when long-term interest rates — in this case, long-term mortgage rates — are below those of their shorter-term counterparts. Inversions usually occur when the Fed has lifted short-term interest rates high enough to suggest to bond traders that growth in the period just ahead will be throttled back to a point where inflation will be kept in check. However, while the Fed has indeed been raising short-term rates in an effort to moderate growth and the potential for inflation, long-term interest rates have remained remarkably restrained in the face of solid growth and inflation which has been on an upward trajectory over the past couple of years. Longer rates respond not only to the Fed’s moves but also to open market conditions reflective of growth, inflation and investor appetite for a given investment.
While bond watchers often look to the spread between the two-year Treasury versus 10-year Treasury to determine if (or when) an inversion occurs, mortgage borrowers can keep an eye on a number of products along the yield curve. Along with the nominal level of interest rates, whether you can get a lot of — or just a little – rate stability for a given price is certainly a consideration when selecting a mortgage product to suit your needs. If the price is almost the same, or even less, why not opt for as much rate stability as you can get, since it’s essentially “free”?
Case in point: with this week’s dip in long-term rates, the average rate for the 30-year FRM and that for a 10/1 Hybrid ARM — a fixed rate for only ten years — are identical. This is the first such pairing since July 2002, when the 10/1 was coming back down from an 18-month inversion. As you might expect, the hybrid was all but abandoned in favor of the longer-term fixed loan. In the last year or so, there has been renewed interest in 10/1 product, but more in interest-only versions than in the fully- amortizing flavor.
Will things become more inverted? It seems likely. The Fed’s campaign of raising short-term rates is expected to have a few “measured” steps left in it, while signs of tempering growth and little new inflation usually suggest lower long-term rates. After a year when ARMs got a lot of play, only artificially low Option- style ARMs may offer payment relief for at least some of 2006, while fixed-rate mortgages may be at prices near or even below Hybrid ARMs. Very long-term fixed, or very short-term option ARMs, seem likely to be the dominant products for 2006, but it’s still early in the year.