Mortgage Rates Dip in Hope of War’s End

If you've seen contradictory headlines about mortgage interest rates today, that's because rates are in an unusual spot. Where rates have been, where they are right now, and where they could go are three separate, but related, stories.

Let's start with where rates have been. The average rate on a 30-year fixed-rate mortgage rose 13 basis points to 6.24% APR in the week ending May 7, according to rates provided to NerdWallet by Zillow. (A basis point is one one-hundredth of a percentage point.) We calculate our weekly average using daily APRs recorded over the last five business days.

But if we're looking at where rates are now, day-over-day we saw a significant drop as markets reacted to the potential for an end to the war in Iran. It wasn't a large enough fall to erase the past few days’ increases. Monday through Wednesday rates were higher as the situation in Iran looked uncertain. Still, mortgage rates today are well below where they were yesterday.

Where mortgage rates will head next is the big question. In the immediate future, there's a lot riding on the situation in Iran. But if we're looking at the longer term, the health of the U.S. economy may be the bigger factor.

Why Iran matters to mortgage rates

Daily mortgage rate movement has been driven by the Iran war since its inception. It's not the easiest path to follow, but let's break it down.

Higher fuel prices have been a major effect of the conflict. Iran is an important oil producer and sits next to the Strait of Hormuz, a key route for global oil shipments. Any disruption there can tighten supply, and we've now had two-plus months of upheaval. Rising energy costs have sparked fears that inflation — which was already running hot — could intensify.

While the stock market has been remarkably strong, inflation concerns have caused trouble for the bond market. Bonds pay a fixed return, called a yield. In an inflationary environment, that fixed return is less desirable. And when investors buy fewer bonds, prices fall and yields go up, since the fixed return is always relative to the bond's price.

Here's where it all comes together. Mortgage rates are generally benchmarked to a specific type of bond, the 10-year Treasury note. Its yield rose quickly when the Iran war began, and mortgage rates went right up with it.

This is the main reason why mortgage rates are in such a precarious position. Earlier this week, when it looked like the U.S. plan to guide ships through the Strait of Hormuz might renew active fighting, the bond market recoiled and mortgage rates spiked.

Now with Iran considering a U.S. proposal to end the war, markets are ebullient and mortgage rates have taken a substantial dive. But it's not over yet. Iran continues to push for control over the Strait of Hormuz, and President Trump has threatened military action if talks break down. Renewed hostilities would, among other things, send mortgage rates right back up.

What the longer term could hold

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For a longer-term perspective on mortgage rates, we can look to the U.S. economy's overall trajectory. That means talking about the Federal Reserve.

At its most recent meeting, the Fed left its benchmark interest rate unchanged for the third time in a row. The Fed doesn’t set mortgage rates, but its decisions strongly influence financial markets and borrowing costs. Mortgage rates often move in anticipation of what the Fed will do next, though — as we've seen with the Iran war — other events can eclipse the central bankers' influence.

The Federal Reserve has two main goals: Keep inflation under control and support a strong job market. Its main source of influence is the federal funds rate, which is the short-term borrowing rate that the Fed controls.

As noted above, inflation was picking up even before the Iran war. The Fed targets a core inflation rate of 2%. ("Core" means minus food and fuel prices, which are volatile in the best of times.) Data released last week by the Bureau of Economic Analysis showed core inflation at 3.2% in March.

Even if war-driven increases in costs prove relatively short-lived, getting inflation back down to the Fed's goal will take some work. The central bankers generally raise the funds rate to slow inflation; the idea is that higher borrowing costs cool off both business and consumer spending. At the Fed's last meeting, three dissenting votes made clear that raising the funds rate needs to be considered.

The job market appears to be doing OK, at least for now. This week has brought both public and private data that showed surprising strength in hiring in March and April. Tomorrow's release of April's jobs report by the Bureau of Labor Statistics will either bolster this rosy outlook or burst the bubble, depending on the direction of unemployment.

A resilient job market is great news unless you're really focused on mortgage rates. Increasing unemployment is one of the strongest arguments for a Fed rate cut, since the central bankers wager that lower borrowing costs encourage businesses to expand and hire. If the job market's looking decent, the Fed holding rates steady becomes the best-case scenario.

Again, the Federal Reserve doesn't set mortgage rates, but when a Fed rate cut is on the horizon, mortgage rates tend to fall. If we're looking at a scenario where the job market's fine but inflation's an issue, we're likely to see rates stay higher for longer.

The article Mortgage Rates Dip in Hope of War’s End originally appeared on NerdWallet.