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Posted 08/18/2008

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What The Surprising Strength Of The U.S. Dollar Is Doing To Mortgage Rates

Before getting marked-up, mortgage rates are based on the price of mortgage bonds, a complex debt security that can be dramatically simplified in three bullet points:

  • An investor buys for the bond for, say, $10,000
  • He collects regular interest payments on his $10,000
  • When the bond "matures", he gets his $10,000 back

It's not specifically stated in the bullet points above, but all the money that changes hands in a bond's lifecycle is paid (and repaid) in U.S. dollars.  This is an important observation because it's one reason why the value of mortgage bonds will, at times, trend closely with the value of the U.S. dollar.

Last week was one of those times. 

As the U.S. dollar rallied into the weekend, the mortgage bond market reversed some its losses from earlier in the week and closed out unchanged from Monday.  It was a remarkable comeback and it happened because the dollar's rising value pumped up the relative worth of those mortgage bond repayments we talked about earlier and that attracted new investors to the market.

Like all securities, more demand drives prices higher and when mortgage prices rise, mortgage rates fall.

But a rising U.S. dollar benefits more than just today's mortgage rate shopping crowd -- it benefit's tomorrow's, too.  This is because a stronger U.S. dollar tends to keep inflation in check.

The dollar's influence on inflation is related to commodities and most are priced in U.S. dollars.  Therefore, when the dollar is strong, commodities tend to be cheap and when the dollar is weak, they tend to be expensive. 

It's a weak dollar, after all, that took most of the heat for the large Cost of Living increases Americans faced earlier this year.  And now we're seeing the reverse. 

Since July, the dollar has regained its footing and commodity prices are plunging.  Oil, for example, is off 33 percent from last month; metal and grains are following suit.  This is good news for Americans because when inflation is in check, mortgage rates have one less reason to rise. 

Remember, inflation is the enemy of mortgage rates so the absence of inflation must be a good thing..

In addition, for as long as inflation remains tolerable, the Federal Reserve is unlikely to raise the Fed Funds Rate.  That will hold Prime Rate at 5.000 percent.  For families with credit card balances and home equity credit lines, a Prime Rate "on pause" means a steady monthly payments.  Most revolving debt is tied to Prime.

Now, a strong dollar won't cure the housing market, but it should help relieve some of the external pressures on it.  A strong dollar should also help keep mortgage rates in check for a while. 

If you're in the market for a new home loan and want to be updated about the mortgage markets specific movements, just follow me on Twitter -- I update several times daily.

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

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