Russia, Ukraine, Interest Rates: Economist Answers Burning Market Questions

Russia, Ukraine, Interest Rates: Economist Answers Burning Market Questions

You know, it’s always good to have a villain in any story and the primary, but certainly not sole, culprit responsible for the jump in rates is you guessed it the Federal Reserve.

As I mentioned earlier, the Fed was the biggest buyer of pools of home loans (otherwise known as mortgage-backed securities) as we moved through the pandemic, but last December they announced an end to what had been an era of easy money by winding down these purchases in order to lay the groundwork for shrinking their 2.7 trillion dollar stockpile of MBS paper they had built up.

This decision to move from quantitative easingto quantitative tighteningso rapidly had an almost immediate impact on mortgage rates simply because the market was going to lose its biggest buyer of mortgage bonds.

Immediately on the heels of their announcement, bond sellers raised the interest rate on their bond offerings to try and find buyers other than the Fed; so lenders raised the rates on mortgages housed within these bond offerings. Finally, mortgage brokers moved quickly to raise the rates that they were quoting to the public.

The result of all this was that rates leapt.

How does inflation play into the rise in rates?

Although we know that the primary party responsible for rates rising was the Fed, there were other players too, and here I am talking about inflation and, as you are no doubt aware, it too started to spike at the beginning of this year and now stands at a level not seen since 1982.

High inflation is a disincentive to bond buyers because if the rate of return – or interest on mortgage bonds – is lower than inflation, investors lose interest pretty quickly.

So, we can blame the Fed, we can blame inflation, but what about Russia?

How has the Russian invasion of Ukraine impacted mortgage rates?

Their invasion of Ukraine on February 24 has certainly influenced mortgage rates – but maybe not in the way you might expect.

You see, in general, when there’s any sort of global or national geopolitical event, investors tend to gravitate to safety, and this invariably means a shift out of equities and into bonds.

So you would be correct in thinking that – at face value – Russia was actually responsible for the tiny drop in rates we saw following the invasion, and also the more significant drop we saw last week when the market saw the biggest two-day drop in rates in over a decade.

But before you start to think that rates are headed back to where they were a year ago, I’ve got some bad news for you. That is almost guaranteed not to happen.

Given what we know today, the terrible conflict in Eastern Europe is highly unlikely to push rates back down to where they were at the start of this year, but they will – at least for now — act as a headwind to rates continuing to head higher at the pace we have seen over recent weeks, and that will continue until the conflict is – hopefully peaceably – concluded.

What impact will rising energy costs have on the economy?

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