Q&A: Why is Bad News Good?
QUESTION: Why is bad economic news typically good for mortgages… and vice versa?
ANSWER: There’s actually a pretty simple explanation for this seemingly strange phenomenon. But, you first need to understand a couple of important financial concepts:
1. Big money managers – who are always in search of higher returns – avoid holding onto cash. So they invest in both Stocks and Bonds.
2. Home loan rates are actually based on the performance of Mortgage Backed Securities (MBS), which are a type of Bond.
When we put those two facts together, we begin to understand the relationship between bad economic news and good home loan rates. Here’s why: Whenever the economy is on fire and there are good economic reports along with positive economic news, investors tend to put more money into Stocks. That’s because Stocks are more risky, but they generally offer higher returns. To do this, however, investors must remove some of their money from less-risky Bonds. This decreased demand in Bonds causes Bond prices to worsen, which causes home loan rates to rise.
Inversely, when the economy is sluggish and economic reports are negative, money managers tend to remove money from higher-risk Stocks and put it into less-risky Bonds. As the demand for Bonds increases, Bond pricing improves and home loan rates decrease.