There is not a tangible relationship between mortgage rates and the stock market whereby one can be said to directly drive the other. Although they both respond to the same market conditions, their response is difficult to predict. That said, there are some notable patters by which either mortgage rates or the stock market suggest the behavior of the other. These patterns are based on flows of investment money, as well as the larger economic impact of either a healthy stock market or low mortgage rates.
Mortgages are Packaged as Bonds
The money that goes to fund mortgage loans comes from investment in mortgage-backed bonds. Mortgages make up a significant part of the bond market. The ten year US treasury yield is often used to track and predict mortgage rates, as they almost always move in concert. When the bond market is doing well, yields and interest rates fall. When investors leave bonds, triggering a bond market sell-off, mortgage rates rise.
The Relationship between Stocks and Bonds
Conventional wisdom suggests that when the stock market rallies, investors are selling bonds to buy stocks. Conversely, when the stock market falls, bond yields and therefore mortgage rates will also decline. This is based on the assumption that the stock and bond markets compete for the same investment money. However, from 2009 through the beginning of 2013, this assumption broke down. Plummeting interest rates accompanied a rising stock market. The stock and bond markets rallied together. This can be credited to an unprecedented mix of economic conditions, along with the activity of the Federal Reserve, which boosted both the stock and bond markets through its asset purchase program, known as Quantitative Easing.
Economics of a Vibrant Housing Market
Low interest rates help to spur the housing market. Housing is a major factor in boosting a healthy economy. This in turn supports a rising stock market. So while in the short term, a falling stock market can drive down interest rates from a macro-economic perspective, those low rates should eventually undergird a stock market rise. This theory was the logic behind the Federal Reserve’s QE activity of the last few years. Some economists fear that as the Fed winds down this program, rising mortgage rates will derail the stock market rally.
Other Drivers of Mortgage Rates
There are a host of other factors that impact mortgage rates on a daily basis. Many of these are completely unrelated to the stock market. Inflation expectation, regulatory changes and even technical patterns can affect mortgage rates. The largest investors in mortgage-backed bonds are Fannie Mae and Freddie Mac. Thus, any change in behavior by these entities can have a significant impact on the price of mortgage bonds, and therefore on rates. Understanding how mortgage rates and the stock market interconnect can help both investors and mortgage holders track patterns and anticipate moves. However, an exact or predictable correlation will never play out.
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