Dubai and Interest Rates

On Friday morning Dubai World, a government owned investment company asked for deferment of payments on approximately $80 billion in debt to various banks and investment companies around the world. Although a relatively small problem in this world of trillions stock markets around the world were rocked by the news. Indeed, it seems that the global financial markets may be more fragile than we had suspected.

As money left the stock markets it flew into dollars and US Treasuries and mortgages. This is actually good news for a couple of reasons. First and most obvious is that when bond prices go up the yields drop. This is good for interest rates on borrowed money like mortgages that no longer have to compete against higher yields driving rates down.

The second, and perhaps more important implication, is that for all the talk of the decline in the dollar as currency of choice and decline in US dominance when push comes to shove the world would still rather be in US dollars and US treasuries than in other secure investment alternatives. This sort of market activity is normal and it is exactly what should happen in times of economic uncertainty. It's nice to see the markets acting like they should when problems occur.

One last word of caution. With all of the investment companies, banks and governments involved in the Carry Trade Dubai's troubles could be the least of our worries. At some point in the very near future inflation will begin to real it's ugly head and rates WILL rise and probably quickly. When this happens all of those highly leveraged trades will have to be unwound and we may have a whole new round of write downs, this time on safe secure holding like treasuries that have been levered up by 10 times or more and rely heavily on a weak dollar. When this happens rates will already be on their way up and this unwinding will exacerbate the problem further and could drive rates higher faster than we would expect.

I don't want to sound doom and gloom here or imply that Dubai's problems are the beginning of the end. Ultimately, they are a small blip that probably got a lot more attention by the market here in the US than they should have because it was the day after Thanksgiving and their wasn't anything else to talk about till Monday or Tuesday when we start getting Black Friday numbers back. Just be cautious and don't get greedy. If your looking for a mortgage or other loan rates are at or near the lowest point they have been in a generation and holding out for an extra 1/4 point is not only foolish but dangerous to your bottom line. Get you loan, put a big smile on your face and enjoy the holidays.

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Why Are Rates So Low?

People call in every day looking for loans. Business is brisk and rates are still really low. Frankly, I was a little puzzled about this most recent rate drop because the data suggests rates should be higher. After all, the Fed has stopped buying treauries while our government continues to borrow money like a shopoholic with a new credit card. At the same time they are also slowing down the purchase of mortgage backed securities and will stop next March. Don’t forget that all this spending WILL cause a spike in inflation and rates MUST go up as a result.

This is all public knowledge so why then are rates down near their lowest level of 2009? The answer lies in supply and demand but not how you may think. In June and July, when rates were up, fewer loans were closed. As a result, as these loans come to market about 3 months later there are fewer loans to available to buy. So even though the Fed has slowed their buying substantially they still made a significant purchase of the AVAILABLE supply of mortgages. Once the current, much higher, volume of loans hits the market supply and demand wins and rates must go higher. The only way this would not occur is if a buyer came in and soaked up the increased supply. This is not likely given inflation concerns and the availability of other well perfoming investments.

So there you have it. Rates will be higher and we can predict with relative certainty when this will occur. Like all markets things don’t move in a straight line so there will be opportunities to lock in on dips in rates as we move higher but expect to see rates in the high fives or low sixes by the middle of next year.