Increased activity in the mortgage market since the GDP revision July 29 has created a noticeable gap between the Primary (borrower) market and the Secondary (Investor) market, as indicated by the wider “spread” shown in Fig.1. You’ll see it’s now almost twice as wide as it was prior to the release, and it’s at the the highest levels we have seen since Oct. 2010.

It was shortly after the last spread widening that we saw rates increase from 4.20% on Nov 20 to 5.19% on Dec 15. The magnitude and the rapid pace of that rate increase caught many market participants by surprise.

“Current Coupon,” as shown below, is represented by the yield on securities guaranteed by Fannie Mae. Loans made to borrowers represented by “30yr Fixed” are eventually packaged into these securities. The “spread” indicates that rates to borrowers could have declined even more than their current levels but instead have remained elevated (despite falling) because …

We care about “real interest rates” (which simply reduce the nominal yield an investor would receive by considering the implied cost of inflation) because lower levels of real interest reduce savings and investment and risk taking the economy further away from any long-term sustainable growth. Short-term low or even negative real yields might be considered a challenge for recovery. But if experienced for an extended period, the economy will no longer be able to allocate capital efficiently, ultimately slowing growth. Think of the economy like riding a bike, with momentum the bike is stable even with a few rocks on the path, slow down until you almost stop and those rocks can easily make you topple over. We have some real challenges ahead with 0.00% real yields.

If you earned 4.00% nominal with your money and you assume 1.00% inflation and 25% tax bracket…your real rate of return is [4.00% x 0.75] – 1.00% = 2.00%

The events of the past week have created an obvious level of tension in global equity and debt markets – so I wanted to place some of this in perspective with a quick graphic. The levels and magnitude of change have broken some records recently and it’s helpful to consider how fast and in what direction rates have moved.

10yr Treasury yields (2.35%) have another 0.30% to decline before they reach the 2.05% Jun’2008 record low.
30yr Fixed Rate Mortgages are at 4.29%, and if you’re shopping you can probably beat the record of 4.21% in Oct’2010.