Many of our clients ask us for advice about the best time to lock in rates to get the lowest possible rate; unfortunately, outside of anticipating certain specific short-term trends in rates, it’s impossible to know where interest rates will go, because those rates are by definition moved by surprising information.

Mortgage interest rates are, for the most part, based on the prices of bonds in the “secondary mortgage market”–when the prices of those bonds increase, prices for mortgages decrease, and when the prices of those bonds decrease, prices for mortgages increase.

So what determines the prices of those bonds? Simplifying greatly, they’re a measure of a lack of confidence in the US economy. When investors think that the US economy is going to be growing, they tend to invest more of their money in stocks (which are risky but which do relatively better as the economy booms) and less in bonds (which are safer but which do relatively worse as the economy booms); similarly, when investors are less sanguine about the future of the economy, they tend to invest more in safer bonds and less in stocks. Prices of stocks and bonds are driven by the same supply & demand concerns that affect everything else, so when the economic outlook is good and money is flowing into stocks rather than bonds, then there is less demand for those bonds, which drives bond prices down (and thus mortgage rates up); conversely, when the economic outlook is bad and money flows into bonds rather than stocks, then the demand for bonds increases, bond prices go up, and mortgage rates go down.

So one piece of conventional wisdom among naive mortgage market watchers is that bad news for the economy is good for mortgage rates, and good news for the economy is bad for mortgage rates, and that borrowers can use that knowledge to “time” the market and lock in their rate before some particular piece of bad news being released.

But here’s the catch: investors in stocks and bonds aren’t just looking at the economy as it is today–they’re looking at every bit of information that they can find to predict where the economy will be going in the future, and they are constantly factoring those expectations about future news into what they are willing to pay for those stocks and bonds today. Imagine, for example, that a news report shows that the economy lost 50,000 jobs last month; a naive market watcher might think that that bad news about the economy would drive investors to safer bonds, and drive down mortgage interest rates. Investors, however, know exactly when every economic report is due to be released, and so a month ago (after the last report), they started making their own guesses about what that jobs report was going to say, and pricing their bids on bonds accordingly; if they were expecting, say, a 70k job loss in that report, then getting that 50k job loss news would actually be good news in terms of expectations for the economy, and bond prices would go down and interest rates would go up.

What does that mean, then? It’s not economic news that moves mortgage rates; it’s unexpected economic news (be it completely unexpected news, or just news whose existence was expected but whose value was unexpected) that moves those rates. And pretty much by definition, you can’t predict that unexpected news unless you’ve got inside information that the thousands of bond traders devoting millions of dollars to research and analysis don’t have. So predicting where rates are going just doesn’t work. (There are a few exceptions to that rule, when looking at rates in the very short term; for example, investors often like to “hedge” their bets in anticipation of the release of certain types of economic news, so it’s possible to sometimes make reasonable predictions like “rates tomorrow morning will go up/go down before the release of Economic Report X”, but those particular movements are usually fairly small, only last for a few hours, and are usually dwarfed by the movements that follow the release of Report X, so that borrowers who try to lock during those short pre-X windows are effectively gambling anyway, betting that the (unpredictable) movement post-X will be in the opposite direction of the pre-X movement.)

Still not convinced that rates are unpredictable? Be sure to read part two of this series of articles, where we go into a little more detail about how to critically evaluate the claims of people who say that they can predict mortgage rate movements–especially if they want to charge you for that information.

And once you’re convinced that you won’t be able to predict where rates will go, you’ll probably be wondering how you should decide when to lock in rates. Here’s our advice on when to lock in your mortgage rate.

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3. Mortgage Market Update 8/7/09
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Tags: mortgage, trends