[Part 2] [Part 3]
[Part 4] [Return
to the blog]
We just said that investors are paying 102% of the face value of a bond in
certain cases right? So what happens if they are not interested at that price
any more? No more liquidity for the mortgage market. So how do you combat this?
In a nutshell, the market forces of supply and demand take
care of it. If demand for a bond is low when the price is 102.00, then the sellers
of the bonds may lower the price to 101.50 to ENTICE investors to start buying
again. And what did we already say would happen to the YIELD when the price
got lower for a particular issue? It goes UP because the same money the investor
was going to spend, now buys more shares. So their rate of return per dollar
spent (yield) goes up.
Those pricing adjustments from 102.00 to 101.50 should look familiar. They
move in exactly the same proportion to YSP. Although Big Bank A has to pull
profit off that for themselves, THE PRICES OF MBS ALWAYS MOVE IN DIRECT PROPORTION
TO THE PRICES (YSP IF POSITIVE, DISCOUNT IF NEGATIVE) OF THE MORTGAGES FROM
WHICH THEY ARE DERIVED.
That is why we want to follow MBS instead of any other treasury
or index in order to gauge the direction of the market. If investors are wanting
to buy more MBS, then the prices are going to go up (Price vs. Demand function).
Higher prices mean that Big Bank A makes more on a given coupon, which means
they can originate a loan for your clients with either a slightly lower interest
rate or a slightly higher YSP. Your choice!
So that is the theme of any mortgage market analysis. We want to assess the
movements of MBS prices (which change by the second), in conjunction
with the macroeconomic climate, in order to determine which way they might be
headed and what future events can have an impact.
For instance, inflation data being negative hurts bonds because bonds return
a fixed income. So if inflation has devalued the dollar over time, the bond
is not really worth as much as when it first was purchased. So high inflation
makes investors seek higher yields in order to get on that boat. Another popular
correlation is that a booming economy draws money out of bonds and into more
rapidly appreciating stocks. This causes bond owners to lower the price to entice
buyers which raises mortgage rates. That is why, if you look at a historical
chart of recessions and interest rates, you will almost always see recessions
coincide with low rates.
Beyond that, there's only a little more you need to know when reading