Markets Are Up in ARMs

Moving Beyond Early-2000s Products

With mortgage rates ticking up to the highest level in several years, we are seeing increased interest in adjustable-rate mortgages (ARMs). Many seasoned homeowners will remember with caution the ARM products of the early 2000s. Today’s ARM products are completely different animals from those that hurt so many borrowers.

Gone are the two-year fixed ARMs that came with a 3-year prepayment penalty, forcing borrowers to keep the loan for three years only to see the third-year rate jump to double digits. Gone are the “Option ARM” products that gave a low teaser rate while actually charging a higher rate and causing negative amortization (an increase in the loan principal balance owed).

Lower Rates, Longer Fixed Periods

Today’s ARM products typically allow borrowers to save 0.5%–1.0% off the comparable fixed rate, taking hundreds of dollars off their payments. This allows more buyers to afford a home. These ARM products typically come with introductory fixed-rate periods of 5, 7, and 10 years. After this, the rate change is capped, depending on the program, creating better protection for borrowers.

For example, the government five-year ARM product from the FHA and the Department of Veterans Affairs has annual rate changes after the introductory period that can only increase 1% annually. This would allow a borrower to refinance or potentially sell their home without an imminent threat of default should the rate increase. Fixed-rate mortgages still account for almost 90% of new originations today, but don’t ignore the ARM.

A Ceiling Takes Shape in the Treasury Yields

Thankfully, markets seem to have found a stabilization point. The 10-year Treasury yield has twice pushed above 5.29% over the past two weeks—including an intraday 24-year high of 5.35% on Thursday—and both times, sellers were overwhelmed by buyers, and the yield was driven right back down.

That repeated rejection is what builds a ceiling. A ceiling is a very strong level that is hard to breach without some major news. This can allow markets to start to claw back some of the damage that has been done.

Oil Prices Fall and Hurricane Risks Remain

Helping to cap bond yields and mortgage rates was an announcement from U.S. President Trump that no attacks on Iran will occur ahead of the November midterm elections. Oil prices dropped to the low $90-per-barrel range.

They remain elevated, however, partly because offshore Gulf oil production has been shut in ahead of Hurricane Isaias, with Gulf Coast refineries also at risk—which would push gasoline prices higher. Our thoughts and prayers go out to the people in the path of the storm expected to make landfall Friday evening.

Global Yields Rise and Treasury Auctions Shine

Global yields are hurting U.S. yields and helping to keep them elevated. France is facing a huge rise in its government bond yields. This is due to France’s debt load of roughly 120% of its GDP, driven by years of deficit spending (spending more than revenue), now running at 5.4% of GDP annually. This has caused other countries’ yields to also rise.

The higher yields are finally becoming attractive to some investors, as the U.S. 10- and 30-year Treasury auctions were very successful this week, also helping to keep yields capped.

Looking Ahead: The CPI and PPI Lead Next Week’s Reports

Next week finds important inflation news with CPI and PPI that could move markets. It is a holiday-shortened week.

• Monday, October 12: Bond markets closed for Columbus Day holiday
• Tuesday, October 13: ADP Weekly and Existing Home Sales
• Wednesday, October 14: Consumer Price Index (CPI)
• Thursday, October 15: Producer Price Index (PPI), Jobless Claims, Retail Sales
• Friday, October 16: Foreign Bond Investment for August, Industrial Production and Capacity Utilization