Bonds Experience a Flight to Safety

Stock Volatility Drives Bond Buying

Mortgage rates continued to improve this week, building on last week’s gains. Most of the improvement comes from investors leaving the more volatile stock markets, especially AI and tech stocks. They take that money and park it in bonds, including mortgage-backed securities, which carry less risk than the stock market. This is called a flight to safety.

The volatility isn’t limited to AI and tech stocks. Paris is on fire, literally, as demonstrators take to the streets to protest their government. Demonstrations have turned into full riots, and the French equivalent of the U.S. 10-year Treasury, the OAT, continues to see yields soar.

Short Covering Pushes Bond Yields Lower

Investors move their money into historically high-yielding bonds. With U.S. 10-year Treasury yields remaining over 5% until this week, that was a great rate of return on a virtually risk-free investment. This bond buying pushes yields lower.

In addition, we’ve recently seen investors take large “short positions” on bonds. This is an investment strategy that allows you to make money when an investment loses value. When investors want to exit a “short position,” they need to purchase the investment they are shorting. This is called covering their position.

Markets are seeing investors covering their short positions in bonds. This buying is also causing yields to decline and is good for rates. It is also an indication that investors think yields and rates may continue to decline.

Higher Rates Benefit Some Savers

An interesting anecdote from this week: This writer had the opportunity to have a conversation with a high schooler taking an AP Macroeconomics class. The student commented that it is good to have high interest rates and bond yields. The question should be: High rates are good for whom?

The answer is a large segment of our population. The baby boomer generation is retiring in droves, and many are living off savings rather than a paycheck. Higher yields mean their CDs, money markets, and bonds finally generate real income again. A retiree with $500,000 in a money market earns roughly $20,000 a year at today’s rates versus almost nothing five years ago.

Lower rates are great for corporate borrowers and anyone who has debt like mortgages, credit cards, and auto loans. We should remember that having high rates are not bad for everyone.

Iran Tensions Support Flight to Safety

The New York Times reported this week that the U.S. and Israel have drawn up plans for renewed strikes on Iran after the U.S. midterm elections. This potential renewal of hostilities is keeping oil prices elevated and is also contributing to some of the flight to safety in bonds.

Housing Starts Fall as Builders Pullback

Housing Starts in September fell over 5% to an annualized pace of 1.2 million units. Completions are also at an annualized pace of 1.19 million units, down 14% from last year. Builders are clearly pulling back on supply to match the reduced demand that has been falling with higher rates. This decrease in housing starts is supportive of home values.

NAHB Sentiment Hits 14-Year Low

Builder confidence also continued to decline with higher rates. The October NAHB Home Builder Sentiment Index fell to just 29 from 32, which is much lower than the breakeven level of 50 and marks a 14-year low. Prospective Buyer Traffic declined to just 18, the lowest since 2012, excluding COVID.

Executive Order Leaves Some Proposals Pending

The real estate industry got excited about a potential executive order from the president. Several of the proposals the industry hoped for did not make the final order outright, including removing or reducing LLPAs and waiving appraisals, income re-verification, and other documentation requirements for eligible refinances. The good news is that they aren’t dead.

Executive Order Targets Mortgage Insurance Relief

What was included was a directive to the Federal Housing Finance Agency (FHFA), the Fannie Mae and Freddie Mac regulator led by Director William Pulte, to develop a pilot program to proactively eliminate mortgage insurance premiums for eligible borrowers based on the current market value of their home.

It also directs the Secretaries of Veterans Affairs and Agriculture to lower rates on VA and USDA loans, respectively. Since those rates are set by Ginnie Mae MBS buying and selling, it remains to be seen how the government can change these rates.

Refinance Proposals Could Reduce Borrower Costs

On the refinance side, the order tells Pulte to expand the title acceptance pilot into an ongoing nationwide program if he determines it is in the best interest of the Enterprises and the public.

If he does, he is required to consider waiving appraisals, income re-verification, and other documentation on limited cash-out refinances that lower a borrower’s payment, along with reducing or eliminating LLPAs on those loans. It also requires that any savings be passed through to borrowers and that lenders disclose them. We remain cautiously optimistic.

Looking Ahead: FOMC Decision Headlines Next Week

Next week is Fed week:

• Tuesday, October 27: ADP Weekly, Case-Shiller and FHFA appreciation reports, New Home Sales, and Durable Goods.
• Wednesday, October 28: Federal Reserve FOMC Rate Decision. As of this writing, markets are pricing in a 91% chance of rates staying the same.
• Thursday, October 29: Personal Consumption Expenditures (PCE, the Fed’s favorite inflation index), GDP, and Jobless Claims.