Why Japanese meltdown means lower U.S. mortgage ratesby Peter Miller
Japan, the world’s third-largest economy, has been hit with an unprecedented series of tragedies. One result from these unfortunate events is likely to be continuing low mortgage rates for those in the U.S.
A massive earthquake and a tsunami of astonishing force have lead to thousands of deaths as well as enormous property losses. Reports indicate that damages could total over $100 billion.
Failures at the Fukushima nuclear facilities have brought on a separate set of problems. At this point, several reactors have been lost and the ultimate extent of the ensuing environmental damage is unknown.
Impacting the bond market
One by-product of the tragedies in Japan has been a massive sell off of stocks and the massive purchase of bonds.
Bonds pay a given rate of interest. Investors know exactly what return they can expect with bonds and that bond returns have some certainty in troubled times. Alternatively, corporate profits are less certain and so are stocks.
More demand means bond prices are rising. As bond prices rise, interest rates go down.
For example: Imagine you can pay $100 for a bond that yields 3 percent. Demand for bonds increases and you can sell the bond for $105. This means that while the bond still pays 3 percent, the yield has declined. The new owner is paying $105 to obtain $3 in income, a yield of 2.86 percent.
Or, imagine if the bond sold for $98. It would still pay a $3 dividend but the yield would increase to 3.06 percent because it now takes less money to get the $3 dividend.
Investors can put their money into bonds and they can also invest in mortgages. To investors, 10-year bonds and 30-year mortgages have a lot of similarities — the reason 30-year mortgages compare with 10-year bonds is that very few mortgages last 10 years.
The result is this: If interest rates for bonds go down, the same will happen with mortgage rates (and vice versa).
The usual thinking has been that interest rates would rise in 2011 because the economy was (and is) showing modest signs of “recovery,” or at least some improvement from the depths of misery seen in 2008. Now, however, all bets are off.
As a result of the earthquake, the tsunami, a volcanic eruption and the nuclear meltdowns, Japanese funds that might have been spent on U.S. goods will instead go for infrastructure and repairs. Productivity will be lost and with it income and savings. Less business activity suggests lower corporate profits, a reduced need for oil and therefore some reason to buy bonds.
The Federal Reserve says, “low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
Translation: Given the historically-low mortgage rates seen last year, it’s been difficult to believe that interest levels would remain so low but here we are despite rising fuel and food prices. It now seems possible that today’s mortgage rates will settle around or below 5 percent for at least the next several months — a window of opportunity for those who wish to purchase or refinance mortgages.