October 21, 2024 • 35 mins
On September 18, the Federal Reserve kicked off the cutting cycle by reducing overnight rates by 50 basis points. Since then, mortgage rates have gone higher. This is not obviously an intuitive thing to happen. The point of a rate cut is to stimulate the economy by reducing the cost to borrow. And people generally know that interest rates and mortgage costs are linked. Well, it turns out they are linked, but not directly. And certainly not in some linear manner. On this episode of the podcast, we speak with Tom Graff, the CIO of the wealth management firm Facet, and a long-time trader in the fixed income space. We talk about the factors that influence mortgage rates, why the spread between a 30-year fixed and a 10-year Treasury fluctuates over time, and how rate cuts can be priced in before they even happen. We also talk about what we'll need to see for mortgage rates to move sustainably lower.
Read More:
US Mortgage Rates Climb to 6.52%, Highest Since Early August
Why a 'Broken' Mortgage Market Is Keeping Borrowing Rates Extra High
See omnystudio.com/listener for privacy information.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
Hey, Odd Blots listeners, Joe and I have something very
exciting to share with you. We are going to be
hosting a live recording of the podcast on the Lower
East Side of New York at Caveat. We're doing it
on November fourth, That is, of course, the night before
the big US election, So join us for an evening
(00:21):
of policy, discussion, trade, all that good stuff. We're going
to be hosting Brad Setzer from the Council on Foreign Relations,
and we'll also have some surprise guests for you as well.
So you can find the link to buy tickets in
our new daily Audlots newsletter or on social media, where
(00:42):
no doubt Joe and I will be talking about it
a lot, so definitely come join us November fourth at
Caveat on the Lower east Side.
Speaker 2 (00:52):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 1 (01:09):
Hello and welcome to another episode of the Odd Lots Podcast.
I'm Tracy Allaway.
Speaker 3 (01:13):
And I'm Joe Wisenthal.
Speaker 1 (01:15):
Joe, have you noticed mortgage rates recently?
Speaker 3 (01:18):
Yeah, they've been up. In fact, we're recording this October sixteenth,
mortgage rates have been rising and in the last couple
of weeks, mortgage applications according to new data out today,
have been down, REFI applications have been down, and of
course it's all ironic because we got that rate cut.
Speaker 1 (01:34):
Yeah, that's right. So benchmark rates have been cut by
fifty basis points, so we've moved to like five percent
from the five point five percent on the upper bound
that happened on September eighteenth. But since then, as you
point out, mortgage rates have actually gone up. So I
think we've moved from like six point six percent on
(01:55):
the thirty year to something like six point nine percent
as we're recording the we were very close to seven
percent last week, and just intuitively, that is not what
you would expect to see happen when benchmark rates are
getting cut.
Speaker 3 (02:10):
All right, I don't want to ever insult fellow colleague,
or not colleagues, but other people in the media and
actually have no basis for this. But in my mind,
there are a bunch of explainers out there on the internet,
is like, what do FED rate cuts mean for you?
And someone put a bullet in there that said, oh,
they mean lower mortgage rates and stuff like that, And
(02:31):
obviously there's a connection between FED rates and what people
pay for a thirty year fixed rate mortgage or some
other flavor of mortgage. But it's clearly not there's reasons
why it's not one to one, and there's nothing mechanical
about the day the FED cuts rates that suddenly borrowing
costs for homeowners drop.
Speaker 1 (02:50):
Yeah, that's right. And this actually came up in our
interview with Chicago Fed President Austin Goolsby talking about what
is the impact of rate cuts on the overall economy
and talked about how everyone has a fixed rate mortgage
now and so that doesn't necessarily feed through, but I
guess it does pose some existential questions for monetary policy transmission.
(03:10):
Like if the benchmark rate was a person, it would
be that guy like pointing at himself in the mirror,
criticizing his own irrelevance. I guess anyway, interesting, that's interesting.
Speaker 3 (03:22):
I wasn't sure we were going with it, but that's interesting.
Speaker 1 (03:25):
That's just what springs to mind.
Speaker 3 (03:27):
You know what I don't get. I mean, I kind
of get it because we've done episodes on mortgages, but
like most mortgages in this country are backed by the
US government or Fany and Freddy implicitly and now more
or less explicitly like, why can't we all just get
mortgages at like the ten year rate for the thirty rate?
You know, Like, seriously, if the government can borrow at
the thirty or rate and the government is backstopping it,
why don't we just all get those same prices for
(03:49):
a mortgage. I know there's reasons, but still I'm not
I need to be reminded what they are.
Speaker 1 (03:54):
Okay, So this episode is going to be all about
why Joe can't get a mortgage at four percent a
ten year rate. We are going to answer that question,
and I'm very happy to say we do, in fact
have the perfect guest for this episode. We're going to
be speaking with Tom Graff. He is the CIO of Facet,
which is a financial planning firm currently has four billion
(04:14):
dollars under management. But perhaps more importantly for the subject,
he was a bond portfolio manager for many, many years,
and when he started out in finance, he was actually
in mortgage bond. So he's gonna walk us through the
sort of mortgage bond ecosystem and all the maths that
(04:35):
goes into producing the final rate.
Speaker 3 (04:38):
I can't wait. I followed Tom on Twitter for a
long time. One of my favorite follows, so I'm really
excited to actra pt.
Speaker 1 (04:43):
Yeah, we finally got him on. Perfect guest for the
perfect topic. Okay, Tom, thank you so much for coming
on a lots.
Speaker 4 (04:49):
Thanks for having me, guys, big fan of the show.
Glad to finally be on.
Speaker 1 (04:52):
So I kind of alluded to it in the intro,
But why don't you give us a rundown of your expertise?
Speaker 3 (04:58):
Why are we talking to you?
Speaker 4 (04:59):
Yeah, securities and yeah, So, as you mentioned, my first
job as analyst, I was a mortgage bond analyst, so
traded mortgages, analyzed mortgage decided what went in the portfolio,
that sort of thing. Then I graduated being a portfolio
manager and I ran a general bond fund but also
ran a mortgage specific fund which was a five star
fund for a while. And now I'm at FACET. I'm
(05:20):
I'm the chief investment officer. I oversee all things investment,
but as a planning firm, we're on the other side.
Now we're helping people decide, well, it's now the right
time to refinance, now the right time to buy a house,
that sort of thing. So I've kind of seen mortgages
from all angles and I've been at this twenty five years,
so I've seen a lot happen over that time.
Speaker 3 (05:37):
So we're gonna really dive deep into this. But big picture,
I actually I don't want to get too much into
the details on the podcast, but I actually have to
refinance a mortgage in a couple of years. I could
do it today, I guess, but I have to do
it at some point. All right, government thirty year yields
are four point three percent four point three to two
percent as we're talking right now. I'll probably want to
(05:59):
get a thirty year fixed. Why can't I just borrow
at four point three two percent if the government is
already backstopping.
Speaker 4 (06:05):
Well, So, the key difference between a mortgage bond and
a treasury bond is that in the United States, virtually
all mortgages, and all the ones that Fannie Maine frendimack back,
can be refinanced at any time without any penalty.
Speaker 3 (06:17):
Can I just promise not to, I guess, because I
can always sell the house or something like that.
Speaker 4 (06:21):
Yeah, yeah, you can't do that, Joe. And so from
an investor perspective, right, what that means is if interest
rates rise, no one refinances. Everyone just stays where they are.
Witness all the people kind of stuck in two and
a half three percent mortgages right now, right, and so
those mortgages just stay outstanding, and they might stay out
standing for thirty years for all we know, right, Whereas
if interest rates fall, you kind of don't get any
(06:43):
of the benefits. So if I buy a thirty year
treasury and interest rates drop, I could make ten, fifteen
to twenty percent price appreciation as that happens. But in
a mortgage bond, if interest rates fall, every just refinances.
I just get all my money back at par I'm
no better off. And so you got to get paid
for that what we'll get into it, but what's called
negative condexity. You've got to get paid for that risk.
(07:04):
And that's why there's a spread between mortgage bonds and
treasury bonds.
Speaker 3 (07:07):
That was perfect, I get it now.
Speaker 1 (07:09):
So who is actually buying mortgage bonds? Because I think
this is going to feed into the discussion of the
spread the yield difference between the tenure and something like
the thirty year mortgage rate. Who's buying?
Speaker 4 (07:22):
Yeah, So it's kind of everybody that plays in the
bond market, but particularly those that play in the high
high quality part. So, as you mentioned, Joe, this whole
market is more or less government backed, and so kind
of the same buyers we're buying a lot of treasury
bonds are probably buying a lot of mortgage bonds, So
that particularly goes to banks and financial institutions. They get
(07:42):
favorable capital treatment versus corporate bonds or something else, so
it's kind of the highest yielding thing they can buy
that has good capital treatment. And then money managers are
certainly buying, particularly ones that are focused on kind of
a general bond benchmarket. It's about thirty percent of the
Bloomberg aggregate. And then you also have a lot of
mortgage rates, so it's an acid that's easy to leverage,
(08:03):
and so there's a lot of players there as well.
Speaker 3 (08:05):
Tracy, I heard a rumor, and I can't say any
I'm going to be very vague about this, but I
recently heard a rumor that there was some sort of
a meeting and there were a lot of economists there,
and I can't say any more details about what it was,
but that actually there is still a widespread misconception, even
among professionals who should know, this perception that banks have
(08:28):
gotten out of the mortgage space that after two thousand
and eight, two thousand and nine, it all sort of
went to what you know, people call non bank lenders
or other asset managers, et cetera. But banks, according to
what you're saying, are still huge holders of mortgages. And
then I guess what's going on with bank balance sheets
et cetera? Really do match?
Speaker 1 (08:44):
Joe? That is so cryptic. You make it sound like
you were at Builderberg or something like some big, top
secret meeting.
Speaker 3 (08:51):
I'm not going to say anymore. This was third hand. Well,
it's an answer you question. I'm not going to insulting anyone.
No one can hear this and oh this was me,
But I'll tell you that I.
Speaker 4 (09:00):
Don't know what Yeah, no one, with no comment on
what Joe might be getting into in his off hours. Yeah. Look,
I think banks have always been big players. Now the
degree to which they buy depends on a lot of things.
So what else could they do with that capital? Is
there are more efficient ways to use that capital, And
in particular right now, the fact that the yield curve
(09:20):
is so flat does make it a little tricky. Right,
So banks their whole game is get in capital at
deposit rates, right, and you guys have done a couple
of shows on how deposit rates have been rising. And
then buy something, you know, whether it's lending or securities
that yield more, and the closer those are, the less
that makes sense, and mortgages there's higher yielding things they
(09:41):
could do. So making a normal commercial and industrial loan
is going to have a higher yield. And so I
think it a flatter curve, just a little trickier for
banks be big buyers. But still in the scheme of things,
there's still big players in the mortgage market for sure.
Speaker 1 (09:53):
So talk to us about what goes into producing a
mortgage rate. So if I want to buy a house,
and I go to a bank and I ask for
a mortgage, what are the individual factors that go into
the number that eventually gets quoted back to me?
Speaker 4 (10:07):
Okay, Yeah, So let's assume for sake of argument, this
is alone that conforms to Fanny and Freddy's standards, because
that's the ones we're talking about here. Okay, So assuming that, right,
your bank has to pay Fanny or Freddy a guarantee fee. Okay,
So that is gfee, the GFI exactly, and that is
based on your credit situation, so how much you're putting down,
(10:30):
what your credit score is, that sort of thing. But
it's all algorithmics, so they're just typing into a computer
or fanning Freddy's kicking back, here's the rate. Right. Then
they're also going to think to themselves, okay, well where
can I sell this mortgage?
Speaker 2 (10:42):
Right?
Speaker 4 (10:42):
What price am I going to get when I sell
it in the open market? And that depends mostly on
just what the general price is for the going rate
for mortgages, but it might depend a little on your situation.
So we can get into it how certain kinds of
mortgages command a bit more of a premium in the
market than others, and that will go in to the
rate you're gonna get quoted. And so every night the
(11:03):
bank's mortgage desk is sort of plugging in, hey for more.
It's like this, we'll offer this rate from words like that,
we're off this right, and all these factors are going
into that. So when your loan officers typing this into
his computer, that's what's spitting out right.
Speaker 3 (11:17):
Actually, let's back up what makes a mortgage conforming versus
non conforming.
Speaker 4 (11:22):
The biggest thing is the price. Okay, So the price
relative to used to be a hard number, but now
Fanny and Freddy do it relative to your sort of
MSA or your area.
Speaker 3 (11:31):
So wait, above a certain price, can you go into
that a little further above a certain price? Fanny and
Freddy just want.
Speaker 4 (11:37):
Yeah, they're just not backing it, and that has to
do with their mandate from Congress to be about affordable housing.
Speaker 3 (11:41):
God, yeah, got.
Speaker 1 (11:57):
So you outlined what happens when we go to a
bank and we get a mortgage. What happens in the
sales process, So that mortgage eventually gets sold on the
open market. As you said, how does it get sold?
Speaker 4 (12:10):
Right? So, the bank's going to pool together a number
of mortgages, and by a number, I mean kind of
any number. You can have a dozen mortgages in a pool.
You could have one hundred thousand mortgages in a pool.
And so they'll but they'll pull them together. What they're
going to try to do is just get best execution,
like any other trade that you do in any other market. Right,
And the way they're going to get best execution is
(12:30):
by grouping the loans together that command a premium. All right,
So let me give it for instance, it is apropos
to Joe's refinancing situation. If you're in New York, if
you have a pool that's all New York loans, that's
going to get a premium. And the reason is because
in New York, this transfer tax makes refinancing more expensive
(12:51):
for a New Yorker. So New York loans refinanced slower
than all the other loans. And so what we call
that in the mortgage business call protection. So if for
every basis point decline in rates, a New York loan
is gonna pay a little slower, and that tends to
be advantageous to the investors. So they're gonna take all
If they've got thirty New York loans and thirty Oklahoma loans,
(13:12):
they're not gonna pull them together because that would waste
their money. They're gonna put all the New York loans
in one loan and get a premium for those, and
just sell all of the Oklahoma ones at the at
the kind of generic.
Speaker 3 (13:22):
Right, that's interesting. So if I'm a buyer, I pay
a little bit more for New York loans because of
that less sensitivity the REFI you know, I was thinking,
so again, I'm not trying to get too into my
personal finances, but I remember around twenty twenty three and
mortgage rates hit eight percent, and a lot of things
that people were saying, including like mortgage brokers you call
(13:44):
you on the phone or whatever right after you enter
into some website like oh, don't worry about the high rates.
You just refinanced in a few years. And I you know,
I'm very emh brained. So I'm thinking like, well, if
everyone is already planning on refinancing in a few years,
then there probably is going to be the great refinance opportunity,
because not everyone can just take that free lunch, you know,
(14:05):
when it is eight percent and everyone's like, yeah, I'm
just going to refinance though in a few years, so
it'll be fine. Does that sort of like factor into
the mouth of how much premium the buyer demand?
Speaker 4 (14:15):
Yeah? I think it really did. And let me give
a very specific example. So right now, the spread between
the tenure Treasury and the mortgage rate is relatively large,
and I'm talking about the investor rate and I'm talking
about the actual borrow rate you get at the bank,
right and so there's a lot of discussion as to
why is that right, And it's been pretty sticky. It's
(14:36):
it's stayed unusually wide for a couple of years now,
and I think one of the reasons is what I
would call severe negative convexity. So negative convexity is this
idea I said earlier, where boy, if interest rates rise,
I don't really get any benefit from buying mortgages, but
if instrates fall, I don't get any upside either, right,
So that's this idea of negative vexity. Well, if you
have everybody laser focused on REFI opportunity, right, maybe the
(15:01):
kinds of people who never check on interest rates, right,
but all of a sudden they're like, I'm checking every day.
I want to know the moment if they're laser focused
on that and the moment they have any opportunity, they're
going to be right on it. Right. Well, that's a
different kind of negative condexity. I'm going to take my
bond that I own is going to refive faster than
it might otherwise at a time that people on mayor
(15:22):
may or may not be paying attention. Right. So, as
an investor, you just mentioned your your efficient markets billed. Yeah,
as an investor, I'm not unaware of that. Right, I'm thinking, boy,
these things are going to pay like a bat out
of hell the moment interest rates drop even a little
and I need to get paid a little more for that.
Speaker 3 (15:39):
Tracy. By the way, you and listeners right now should
go to Google Trends and look for a search of
the word no. Seriously is a great charge. Someone had
showed to me this a few.
Speaker 1 (15:49):
Weeks discussing line goes up.
Speaker 3 (15:51):
Look at the word Do a Google Trends search for
the word refinancing, and you will see a big spike
on September eighteenth because it was you know, not everyone's
always paying attention to rates, But there's like one day
this year where the Fed actually made some pretty significant
news that sort of broke through the bubble, and you
could see how suddenly there were a bunch of people
paying attention to rates. Ironically, they didn't get any real
(16:13):
benefits automatically, but you could see how people don't pay attention.
And then there's a day when someday they were.
Speaker 1 (16:19):
The futility of doing Google research. Everyone wants to refile
on that specific date and they can't get a lower
rate anyway. Tom I wanted to ask, what is the
ideal environment to be buying mortgages in because I think
back to the years after two thousand and eight when
interest rates were really low, and I remember big investors
(16:40):
in mbs. They always complained, you know, they didn't want
to get prepaid because then they would have all this
extra money that they would have to reinvest at lower rates.
But now we're in the higher rate environment and they're
also complaining, So like, what is the ideal here?
Speaker 4 (16:57):
Yeah, So one way to think about mortgage investing is
and I'm going to play on another odd lots theme here, please,
It's a little like doing a covered call strategy in
a stock all right. So what I've kind of done
is I bought a bond and I've also sold an
option to the borrower, and that option is to call
(17:17):
my bond away, right. And it's just like if I
buy Microsoft and I sell an option for someone to
buy Microsoft from me. It's exactly the same trade. And
if you think about that trade, right, what you want
is for Microsoft to do nothing, because if it goes down,
I've lost money. If it goes up, I get called away, right,
But if it does nothing, I just collect that premium
(17:37):
and I still have my stock. Right, So what you
want is for interest rates to stay very steady. Okay,
and nobody really gets to refinance. But I don't suffer
the downside that I suffer if interest rates rise, and
so mortgage is it's a tough It can be a
tough total return bond. So like if you think about
someone trying to trade it and play interest rates move around,
(18:00):
that's not that great. What it is is a good
income bond. So I buy it to collect this income.
If interust rates can stay steady, it can be a
great bond to own.
Speaker 1 (18:08):
And this is why people call them pass throughs, right.
Speaker 4 (18:10):
Well, yeah, passive. The other thing people will say is
it can be a good defensive bond. So if you
think that corporate bonds are going to suffer because there's
gonna be a recession, a lot of times people will
rotate into mortgage bonds because they're still yield there and
they're not as sensitive to that part of the cycle.
Usually when that happens, interest rates drop a lot and
you're not getting that upside and so I don't know,
(18:32):
there's a tough space. It's a tough space.
Speaker 3 (18:34):
Do Americans under refinance? I mean there must be some
population that doesn't pay attention. So I'm looking at you know,
mortgage rates in twenty ten, at one point December thirty first,
twenty ten, they're at four point nine to nine percent.
They had gotten as low in twenty sixteen at three
point three percent. You know, I imagine in your covered
call strategy, anyone engaging in these things are very sophisticated
(18:57):
and you call it right away. Is there an advance
for mortgage buyers sort of taking advantage of the fact
that the counterparty to this trade is not watching rates
all day?
Speaker 4 (19:07):
No, for sure, that is true. So this concept in
mortgage trading called burnout, okay, and this is the idea
that at a certain point everyone who's going to refinance
has refinanced. Yeah, So if we rewind to twenty twenty,
twenty twenty one, r ine traates were really low, you'd
still see five percent mortgages outstanding, and you'd be like, well,
why what are they doing?
Speaker 3 (19:26):
Get on life right and not paying attention to an
interest rate right now?
Speaker 4 (19:29):
Sometimes they're just not paying attention. Sometimes they may maybe
something's happened with their credit and they can't get a
lower rate at this point, which you can get a
ton of detail on what the mortgage conditions were when
the bar were initiated the mortgage, but you don't know
that much about where they are in their life now, right.
You just really only know what happened when they applied.
So you can get that. You can also get people
(19:51):
who are thinking about just paying off the loan and
they don't want to restart the clock. So if I've
been in this house for ten years and you're like,
I know, I get a lower rate, but then I
got to reset the clock, maybe a fifteen year more
you do a fifteen year old origion, but maybe that
monthly P and I is too much for me.
Speaker 3 (20:05):
So there's something nice about just paying off a mortgage.
Speaker 4 (20:07):
And accutely, And that's a personal preference. Some people that's
what they want to do. Some people think that's a
bad financial idea, but I think it's up to you.
But anyway, that certainly happens, right, And so it's not
all just not paying attention, but it's not there's an
element of that for sure.
Speaker 1 (20:36):
I want to go back to the spread between mortgage
rates and treasuries, which, as you pointed out, has been
pretty wide in recent years. And I know You mentioned
the negative convexity point, but do you see anything like
structural that's happened in the market that has led to
that bigger spread.
Speaker 4 (20:54):
Yeah, Well, the flat curve they mentioned is part of it, right,
because there's a lot of players. Normally the arbitrage would
be hey, leveraged owners, which could be banks, but could
also be mortgage rates, other hedge funds. Anybody could come
in by the mortgage rate at this relatively high maybe
hedge it with treasuries and borrow in the repo market,
do that whole trade up. But it should work, right,
(21:15):
But if the curve's pretty flat, then you need more
heeld to make it work, and all of a sudden
there's no arm there, right, So I think that's part
of it. I also think the fact that people see
the housing market as a little frozen right as part
of it, right, because there's so many people in one
part in very low rates they're kind of stuck there,
and there's people in very high rates they're kind of
like unable to refinance right now. So I think that's
(21:38):
part of it. I think that earlier I'm going to
go back to my call writing analogy. There's a vix
to the interest rate world. It's called the move index.
You can look at on by your terminal and you
can see that's relatively high. And that plays into how
people think about mortgages because if the volatility of interest
rates is relatively high, then the cost of the option
is relatively high, the cost of the options is relatively
(22:00):
then the mortgage rates can be relatively eye right. So
I think that all plays into it. In my opinion,
the negative convexity bit is the most important one. The
vall bit could improve as we get a little more
clarity on the FED if we stop whipping from oh,
if it's going to do eight cuts, No, they're going
to do two. If we could get into like, okay,
we kind of know the path here, then I think
that voll bit could come down. But and that might
(22:21):
be worth twenty twenty five basis points on the mortgage rate,
But I don't think we're in all the way to
more historic norms of like one hundred and fifty basis
points spread from treasuries to mortgages until we get a
little bit less negative convexity.
Speaker 1 (22:33):
Thank you so much, by the way for tying the
move index to mortgage rates, because I'm actually writing about
it in our newsletter today, the Odd Thoughts Newsletter now.
Speaker 3 (22:42):
Daily Odd Launch newsletter used to be weekly. Go there
and sign up for it.
Speaker 1 (22:46):
Yeah, that was my very eloquent plug for the newsletter. Okay, Tom,
at what point does the spread like get wide enough
that it does entice buyers into the market. Presumably they're
it must be like a level at which it does
become interesting. Or is it the case that it's just
never going to compete with something like, I don't know,
(23:08):
a commercial mortgage or a high yield bond or something
like that.
Speaker 4 (23:12):
Well, you know, I would say at the beginning part
of this year, mortgages became a really popular trade in
the money management business. So I'm just talking about regular
old bond funds. I heard a lot of people talking
up this trade, and the reasons were what you described.
They're like, look, the spreads are really wide. At that time,
we were saying, you know, the Fed's done hiking, maybe
a cut's coming. Maybe that'll cause in straight vault to decline,
(23:36):
So there could be a spread compression opportunity here. I
think there was also an argument that there could be
some risk of corporate spreads widening corporate spreads were really tight,
and so relative to corporate spreads, mortgages were pretty attractive.
And mortgages have performed fine if it's not been a disaster,
but they've underperformed corporate bonds. And I think the problem
has been that this negative convexity issue is interest rates
(23:56):
have dropped, mortgages have just underperformed, and corporate spreads have
keeped tightening. And so money managers have been underweight corporate
bonds for a decade. If you go back and just
look at a soil chart of where general bond funds are,
they've been underweight mortgages forever. So there is an opportunity
for them to come in. But like I think that
started happening and they all got disappointed, and so we'll
see if that continues.
Speaker 3 (24:17):
You know, earlier when you said you're going to touch
on a odd blog see theme, you said the move index.
But I thought you were going to go to the
supply chain aspect, because there is this supply chain right
of mortgages. And I remember that in like summer or
spring of twenty twenty, when interest rates were sent to zero,
(24:37):
that one of the stories that was out there was
that there was so much demand for refin activity that
actually the humans who had to do it, oh where
they were human capital.
Speaker 1 (24:48):
Married under paperwork because there's.
Speaker 3 (24:50):
A lot of paperwork, which also speaking of why people
might not refly like paperwork, it's a really annoying especially
after the Great Financial Crisis, just hundreds of documents. That's
not fun. Can you talk a little bit about the
sort of like the infrastructure of mortgage capacity and how
that's evolved over time?
Speaker 4 (25:07):
Sure, sure, I do. I feel like we're hitting odd last,
that's very real. And what the banks will do is
they'll assess, well, boy, how many mortgages can we process
in a day? Right, and that will help them set
the rate right, because there's no sense in being overly
competitive with your rate if I can't even process right. So, yeah,
(25:28):
so that is that absolutely can be an issue now
right now. The opposite is there there's just not enough
business to be done, right. You just mentioned applications being
so low, and so that probably has resolved in a
little under hiring in the space. Right. Maybe there'st been
a ton of lay offs, but there certainly has not
been a ton of hiring, right, And so maybe maybe
that's just through attrition head councer down in that space.
(25:48):
And so if there is a surprise and in twelve
months mortgage rates are four or some such, we will
absolutely be talking about that. Again.
Speaker 3 (25:55):
Absolutely interesting.
Speaker 1 (25:56):
So I'm going to ask the question that I'm sure
is on everyone's mind per that Google trends chart, but
when do mortgages come down?
Speaker 3 (26:04):
Yeah?
Speaker 4 (26:05):
Or what will it take it?
Speaker 1 (26:06):
Yeah?
Speaker 4 (26:06):
So we should. Let's let's talk about why they've risen
since that FED meeting, and then that I think that'll
inform where they're headed. Right, So, look, the tenure treasury
is not a function of where the FED is today.
It's a function of where people anticipate the FED being
in the next year two, three, right, and beyond three
it's sort of fuzzy, but like you know, year two,
(26:27):
we sort of have a sense, right, we can make
a guess. And so going into that September meeting, people
started thinking themselves, Boy, then my cut fifty basis points
in September, fifty basis points in November, maybe even fifty
more basis points in December. Right, you pull up your
WRP chart on the terminal. You can see this, right
if you go back to then. But since then, what happened.
(26:49):
We got a big jobs report the beginning of October.
That was the September report, but came out October, and
that was kind of a game changer, because not only
did we get a solid number for September, but it
was huge upward revisions kind of erased what looked like
a downward trend in hiring. Right. Well, now all of
a sudden, we're like, boy, the FED might be a
lot closer to that neutral rate than we think. Right,
(27:12):
They're probably gonna still cut in November, but maybe they'll
cut in December. Maybe they won't, but if they do,
it's certainly not gonna be fifty basis points unless something changes.
And so that change in expectations has caused a tenure
to rise, so commensurately the mortgage rate has risen, right,
And so from that store you can say, all right,
well it comes pretty easy to see what's going to
(27:32):
cause mortgage rates to drop. The tenure needs to drop, right,
And what's going to cause the tenure to drop, Well,
we're gonna need more FED cuts priced in. What's going
to cause more FED cuts get priced in? We need
the economy to get weaker.
Speaker 3 (27:44):
By the way, I'm just gonna I'm not gonna pose
this as a question. But another thing that has happened
since September eighteenth is that the odds of Donald Trump
winning have gone up significantly if you look at the
betting market, and there is a widespread view among economists
that thanks to tariffs tax cuts, that could also mean
a reflationary impulse in the economy starting maybe early next year.
(28:07):
So I'm just throwing out there. You know, you mentioned
the jobs report, but policy may get more reflationary after January.
Speaker 4 (28:14):
That I do think that's the consensus view that it's
starting out as it means higher interest rates. Like, we'll
just see if that happens. But I think the key
here is that it's about an anticipation period because even
what you're saying, Joe about potential, you know, change in
physical policy functions, what you're saying, right, that's a big change.
That's an anticipation as well, right, So it's all about
what's being anticipated now, what's happening in real time.
Speaker 3 (28:36):
By the way, Tracy, obviously Tom mentioned people looking forward,
and you know, people, it's funny people are talking about
long and variable legs with monetary policy. But I increasingly
think it should be long and variable leads because rates
have been falling for over a year, well before the
FED formally Yeah about cuts. So there's a sense in
which he's one of my favorite phrases, you know, is
(28:59):
priced in.
Speaker 1 (29:00):
Yeah, markets be four at looking, that's for sure.
Speaker 4 (29:03):
Tom.
Speaker 1 (29:03):
You know, we would be remiss if we didn't ask
a veteran MBS trader and analyst what two thousand and
eight was, like, give us some war stories.
Speaker 4 (29:14):
I mean, I lost a lot of weight, super stressed.
Speaker 3 (29:16):
No, that's great.
Speaker 4 (29:17):
Yeah, yeah, it was the worst reason I've ever had
was What was wild about that time was no one
really knew how deep it could get, right, Like, there
was a lot of assumptions people made, well, I mean,
if this happens, then like, but we also were living it, right.
So when Fanny ma and Freddy Mack were taken over
in the beginning part of September, this was a week
or there's about two weeks I believe before Lehman failed,
(29:40):
which is almost equally as big a deal, but kind
of forgotten to history was Fanny made Freddy Mack were
taken over because they were functionally insolvent and they became
under pressure through early on nine to sell down their
mortgage portfolio. Okay, so at that time, Tracy, you asked
who buys mortgages? Well, at that time I said, well,
Fanny made Freddimac. They're they're number one. So they were
(30:02):
not only guarantee mortgages, but they were a big buyer. Okay,
And is that left the market? Not only was there
just a ton of fear, was lack of capital available
in general, which had this big player who was kind
of gone, right, And so mortgage spreads, the spread we
were talking about between treasuries and with that went through
the roof, right, So and then we had to reassess like, well,
(30:23):
what does this mean if this big player's footprint is gone.
And then of course as they became more of a
permanent war to the state, how they went about guaranteeing mortgages,
what the GFE, how the gfe's worked, all that stuff
got reformed, and so it's been a massive change in
the space for sure. You know.
Speaker 3 (30:41):
Just one last question for me, and again it's sort
of technical, all this paperwork, why can't we just have
like one is it just impossible to imagine that one
click refise whatever exists because of all the credit check
you know, I'm just like used to everything else finance,
like one click move of your account from here to hear,
one click do to this, And I was like, why
does someone offer one click mortgage REFI is just is
(31:02):
it just always going to be too much human capital
intensive for something like that because you've been a great product.
Speaker 4 (31:08):
Yeah, my bet is that regulation makes that hard. Right, So, like,
if you're gonna sell it to fan, we're gonna get
the guarantee. You actually, you actually can get guarantee without
selling the mortgage. But let's say you're gonna get the guarantee,
then you're gonna have to go through Fanny and Freddy's hoops,
which you won't be shocked to know that their computer
systems aren't aren't the greatest. So you always have that right.
And then but the bank itself is going to have
(31:30):
to follow certain regulations even it's going to keep the
loan on book, right, And so I suspect that's that
element makes that difficult. That would be my bet.
Speaker 1 (31:38):
I feel like that's usually the answer to questions about like, well,
why don't we just use technology to make it easier.
It's usually regulation.
Speaker 3 (31:45):
I wonder if there's ever been any like why combinator
startups like we're going to do one click reefise, et cetera,
and then they run into it's like, oh, actually, there's
just a bunch of reasons why this product doesn't exist anyway.
Speaker 1 (31:54):
Yeah, if you've run a failed one click mortgage startup,
let us know and we'll have you on the podcast.
All right, Tom, that was absolutely amazing. You were truly
the perfect guest to talk about high mortgage rates. So
thank you so much for coming on off on.
Speaker 4 (32:09):
Thanks for having me, Joe.
Speaker 1 (32:22):
That was so good to have Tom on talking about
all of this, And I do feel like I understand
it more. It is funny. I mean, I do think
when you think of easing in monetary policy, like one
of the big transmission mechanisms is still supposed to be
mortgage rates. Right. But I think if we've learned one
thing from our current experience, it's that that doesn't always
(32:46):
necessarily pass through. The pass throughs don't pass through.
Speaker 3 (32:50):
Yeah, I would say two things. It's like the pass
throughs don't happen in a very linear, predictable way. There
is nothing that happened on September eighteenth that made everybody's cost.
There are some instruments, you know, short term instruments that
are directly tied to the FED funds rate, but nothing
mechanical happened on September eighteenth that just like made cost
borrowing and everyone new September eighteenth or that a FED
(33:14):
cut was eventually coming as inflation started to roll over
after its peak, and therefore the FED cutting did create
lower rates. It just happened in anticipations cut rather than afterwards.
But it is ironic then that you get that big
surge in people looking for refinance after it was fully
priced in.
Speaker 1 (33:31):
I do like your leading lag idea.
Speaker 3 (33:33):
Thank you.
Speaker 1 (33:34):
You should write about that in the newsletter.
Speaker 3 (33:36):
That's a good idea. Maybe I'll write about it Monday,
our new daily Odd Lots newsletter. Maybe I'll write about
it Monday when this episode comes out.
Speaker 1 (33:43):
Yeah, Okay, I think we've said new daily newsletter enough
on this episode. Shall we leave it there?
Speaker 3 (33:48):
Let's leave it there.
Speaker 1 (33:49):
This has been another edition of the All Thoughts Podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (33:55):
And I'm Jill Wisenthal. You can follow me at The
Stalwart follow Tom Graff. He's at tdgraph. Follow our producers
Carmen Rodriguez at Carmen Erman dash, Ol Bennett at Dashbot
and kill Brooks at Kilbrooks. Thank you to a producer,
Moses Ondem. For more Oddlots content, go to Bloomberg dot
com slash Odloffere have transcripts, a blog, and a new
(34:16):
daily newsletter.
Speaker 1 (34:17):
And if you enjoy Odd Lots, if you like it
when we dive into the math behind mortgage rates, then
please leave us a positive review on your favorite podcast platform.
And remember, if you are a Bloomberg subscriber, in addition
to getting our new daily newsletter, you can also listen
to all of our episodes absolutely add free. All you
(34:38):
need to do is find the Bloomberg channel on Apple
Podcasts and then follow the instructions there. Thanks for listening.
Hey, Odd Blots listeners, Joe and I have something very
exciting to share with you. We are going to be
hosting a live recording of the podcast on the Lower
East Side of New York at Caveat. We're doing it
on November fourth, That is, of course, the night before
the big US election, So join us for an evening
(00:21):
of policy, discussion, trade, all that good stuff. We're going
to be hosting Brad Setzer from the Council on Foreign Relations,
and we'll also have some surprise guests for you as well.
So you can find the link to buy tickets in
our new daily Audlots newsletter or on social media, where
(00:42):
no doubt Joe and I will be talking about it
a lot, so definitely come join us November fourth at
Caveat on the Lower east Side.
Speaker 2 (00:52):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 1 (01:09):
Hello and welcome to another episode of the Odd Lots Podcast.
I'm Tracy Allaway.
Speaker 3 (01:13):
And I'm Joe Wisenthal.
Speaker 1 (01:15):
Joe, have you noticed mortgage rates recently?
Speaker 3 (01:18):
Yeah, they've been up. In fact, we're recording this October sixteenth,
mortgage rates have been rising and in the last couple
of weeks, mortgage applications according to new data out today,
have been down, REFI applications have been down, and of
course it's all ironic because we got that rate cut.
Speaker 1 (01:34):
Yeah, that's right. So benchmark rates have been cut by
fifty basis points, so we've moved to like five percent
from the five point five percent on the upper bound
that happened on September eighteenth. But since then, as you
point out, mortgage rates have actually gone up. So I
think we've moved from like six point six percent on
(01:55):
the thirty year to something like six point nine percent
as we're recording the we were very close to seven
percent last week, and just intuitively, that is not what
you would expect to see happen when benchmark rates are
getting cut.
Speaker 3 (02:10):
All right, I don't want to ever insult fellow colleague,
or not colleagues, but other people in the media and
actually have no basis for this. But in my mind,
there are a bunch of explainers out there on the internet,
is like, what do FED rate cuts mean for you?
And someone put a bullet in there that said, oh,
they mean lower mortgage rates and stuff like that, And
(02:31):
obviously there's a connection between FED rates and what people
pay for a thirty year fixed rate mortgage or some
other flavor of mortgage. But it's clearly not there's reasons
why it's not one to one, and there's nothing mechanical
about the day the FED cuts rates that suddenly borrowing
costs for homeowners drop.
Speaker 1 (02:50):
Yeah, that's right. And this actually came up in our
interview with Chicago Fed President Austin Goolsby talking about what
is the impact of rate cuts on the overall economy
and talked about how everyone has a fixed rate mortgage
now and so that doesn't necessarily feed through, but I
guess it does pose some existential questions for monetary policy transmission.
(03:10):
Like if the benchmark rate was a person, it would
be that guy like pointing at himself in the mirror,
criticizing his own irrelevance. I guess anyway, interesting, that's interesting.
Speaker 3 (03:22):
I wasn't sure we were going with it, but that's interesting.
Speaker 1 (03:25):
That's just what springs to mind.
Speaker 3 (03:27):
You know what I don't get. I mean, I kind
of get it because we've done episodes on mortgages, but
like most mortgages in this country are backed by the
US government or Fany and Freddy implicitly and now more
or less explicitly like, why can't we all just get
mortgages at like the ten year rate for the thirty rate?
You know, Like, seriously, if the government can borrow at
the thirty or rate and the government is backstopping it,
why don't we just all get those same prices for
(03:49):
a mortgage. I know there's reasons, but still I'm not
I need to be reminded what they are.
Speaker 1 (03:54):
Okay, So this episode is going to be all about
why Joe can't get a mortgage at four percent a
ten year rate. We are going to answer that question,
and I'm very happy to say we do, in fact
have the perfect guest for this episode. We're going to
be speaking with Tom Graff. He is the CIO of Facet,
which is a financial planning firm currently has four billion
(04:14):
dollars under management. But perhaps more importantly for the subject,
he was a bond portfolio manager for many, many years,
and when he started out in finance, he was actually
in mortgage bond. So he's gonna walk us through the
sort of mortgage bond ecosystem and all the maths that
(04:35):
goes into producing the final rate.
Speaker 3 (04:38):
I can't wait. I followed Tom on Twitter for a
long time. One of my favorite follows, so I'm really
excited to actra pt.
Speaker 1 (04:43):
Yeah, we finally got him on. Perfect guest for the
perfect topic. Okay, Tom, thank you so much for coming
on a lots.
Speaker 4 (04:49):
Thanks for having me, guys, big fan of the show.
Glad to finally be on.
Speaker 1 (04:52):
So I kind of alluded to it in the intro,
But why don't you give us a rundown of your expertise?
Speaker 3 (04:58):
Why are we talking to you?
Speaker 4 (04:59):
Yeah, securities and yeah, So, as you mentioned, my first
job as analyst, I was a mortgage bond analyst, so
traded mortgages, analyzed mortgage decided what went in the portfolio,
that sort of thing. Then I graduated being a portfolio
manager and I ran a general bond fund but also
ran a mortgage specific fund which was a five star
fund for a while. And now I'm at FACET. I'm
(05:20):
I'm the chief investment officer. I oversee all things investment,
but as a planning firm, we're on the other side.
Now we're helping people decide, well, it's now the right
time to refinance, now the right time to buy a house,
that sort of thing. So I've kind of seen mortgages
from all angles and I've been at this twenty five years,
so I've seen a lot happen over that time.
Speaker 3 (05:37):
So we're gonna really dive deep into this. But big picture,
I actually I don't want to get too much into
the details on the podcast, but I actually have to
refinance a mortgage in a couple of years. I could
do it today, I guess, but I have to do
it at some point. All right, government thirty year yields
are four point three percent four point three to two
percent as we're talking right now. I'll probably want to
(05:59):
get a thirty year fixed. Why can't I just borrow
at four point three two percent if the government is
already backstopping.
Speaker 4 (06:05):
Well, So, the key difference between a mortgage bond and
a treasury bond is that in the United States, virtually
all mortgages, and all the ones that Fannie Maine frendimack back,
can be refinanced at any time without any penalty.
Speaker 3 (06:17):
Can I just promise not to, I guess, because I
can always sell the house or something like that.
Speaker 4 (06:21):
Yeah, yeah, you can't do that, Joe. And so from
an investor perspective, right, what that means is if interest
rates rise, no one refinances. Everyone just stays where they are.
Witness all the people kind of stuck in two and
a half three percent mortgages right now, right, and so
those mortgages just stay outstanding, and they might stay out
standing for thirty years for all we know, right, Whereas
if interest rates fall, you kind of don't get any
(06:43):
of the benefits. So if I buy a thirty year
treasury and interest rates drop, I could make ten, fifteen
to twenty percent price appreciation as that happens. But in
a mortgage bond, if interest rates fall, every just refinances.
I just get all my money back at par I'm
no better off. And so you got to get paid
for that what we'll get into it, but what's called
negative condexity. You've got to get paid for that risk.
(07:04):
And that's why there's a spread between mortgage bonds and
treasury bonds.
Speaker 3 (07:07):
That was perfect, I get it now.
Speaker 1 (07:09):
So who is actually buying mortgage bonds? Because I think
this is going to feed into the discussion of the
spread the yield difference between the tenure and something like
the thirty year mortgage rate. Who's buying?
Speaker 4 (07:22):
Yeah, So it's kind of everybody that plays in the
bond market, but particularly those that play in the high
high quality part. So, as you mentioned, Joe, this whole
market is more or less government backed, and so kind
of the same buyers we're buying a lot of treasury
bonds are probably buying a lot of mortgage bonds, So
that particularly goes to banks and financial institutions. They get
(07:42):
favorable capital treatment versus corporate bonds or something else, so
it's kind of the highest yielding thing they can buy
that has good capital treatment. And then money managers are
certainly buying, particularly ones that are focused on kind of
a general bond benchmarket. It's about thirty percent of the
Bloomberg aggregate. And then you also have a lot of
mortgage rates, so it's an acid that's easy to leverage,
(08:03):
and so there's a lot of players there as well.
Speaker 3 (08:05):
Tracy, I heard a rumor, and I can't say any
I'm going to be very vague about this, but I
recently heard a rumor that there was some sort of
a meeting and there were a lot of economists there,
and I can't say any more details about what it was,
but that actually there is still a widespread misconception, even
among professionals who should know, this perception that banks have
(08:28):
gotten out of the mortgage space that after two thousand
and eight, two thousand and nine, it all sort of
went to what you know, people call non bank lenders
or other asset managers, et cetera. But banks, according to
what you're saying, are still huge holders of mortgages. And
then I guess what's going on with bank balance sheets
et cetera? Really do match?
Speaker 1 (08:44):
Joe? That is so cryptic. You make it sound like
you were at Builderberg or something like some big, top
secret meeting.
Speaker 3 (08:51):
I'm not going to say anymore. This was third hand. Well,
it's an answer you question. I'm not going to insulting anyone.
No one can hear this and oh this was me,
But I'll tell you that I.
Speaker 4 (09:00):
Don't know what Yeah, no one, with no comment on
what Joe might be getting into in his off hours. Yeah. Look,
I think banks have always been big players. Now the
degree to which they buy depends on a lot of things.
So what else could they do with that capital? Is
there are more efficient ways to use that capital, And
in particular right now, the fact that the yield curve
(09:20):
is so flat does make it a little tricky. Right,
So banks their whole game is get in capital at
deposit rates, right, and you guys have done a couple
of shows on how deposit rates have been rising. And
then buy something, you know, whether it's lending or securities
that yield more, and the closer those are, the less
that makes sense, and mortgages there's higher yielding things they
(09:41):
could do. So making a normal commercial and industrial loan
is going to have a higher yield. And so I
think it a flatter curve, just a little trickier for
banks be big buyers. But still in the scheme of things,
there's still big players in the mortgage market for sure.
Speaker 1 (09:53):
So talk to us about what goes into producing a
mortgage rate. So if I want to buy a house,
and I go to a bank and I ask for
a mortgage, what are the individual factors that go into
the number that eventually gets quoted back to me?
Speaker 4 (10:07):
Okay, Yeah, So let's assume for sake of argument, this
is alone that conforms to Fanny and Freddy's standards, because
that's the ones we're talking about here. Okay, So assuming that, right,
your bank has to pay Fanny or Freddy a guarantee fee. Okay,
So that is gfee, the GFI exactly, and that is
based on your credit situation, so how much you're putting down,
(10:30):
what your credit score is, that sort of thing. But
it's all algorithmics, so they're just typing into a computer
or fanning Freddy's kicking back, here's the rate. Right. Then
they're also going to think to themselves, okay, well where
can I sell this mortgage?
Speaker 2 (10:42):
Right?
Speaker 4 (10:42):
What price am I going to get when I sell
it in the open market? And that depends mostly on
just what the general price is for the going rate
for mortgages, but it might depend a little on your situation.
So we can get into it how certain kinds of
mortgages command a bit more of a premium in the
market than others, and that will go in to the
rate you're gonna get quoted. And so every night the
(11:03):
bank's mortgage desk is sort of plugging in, hey for more.
It's like this, we'll offer this rate from words like that,
we're off this right, and all these factors are going
into that. So when your loan officers typing this into
his computer, that's what's spitting out right.
Speaker 3 (11:17):
Actually, let's back up what makes a mortgage conforming versus
non conforming.
Speaker 4 (11:22):
The biggest thing is the price. Okay, So the price
relative to used to be a hard number, but now
Fanny and Freddy do it relative to your sort of
MSA or your area.
Speaker 3 (11:31):
So wait, above a certain price, can you go into
that a little further above a certain price? Fanny and
Freddy just want.
Speaker 4 (11:37):
Yeah, they're just not backing it, and that has to
do with their mandate from Congress to be about affordable housing.
Speaker 3 (11:41):
God, yeah, got.
Speaker 1 (11:57):
So you outlined what happens when we go to a
bank and we get a mortgage. What happens in the
sales process, So that mortgage eventually gets sold on the
open market. As you said, how does it get sold?
Speaker 4 (12:10):
Right? So, the bank's going to pool together a number
of mortgages, and by a number, I mean kind of
any number. You can have a dozen mortgages in a pool.
You could have one hundred thousand mortgages in a pool.
And so they'll but they'll pull them together. What they're
going to try to do is just get best execution,
like any other trade that you do in any other market. Right,
And the way they're going to get best execution is
(12:30):
by grouping the loans together that command a premium. All right,
So let me give it for instance, it is apropos
to Joe's refinancing situation. If you're in New York, if
you have a pool that's all New York loans, that's
going to get a premium. And the reason is because
in New York, this transfer tax makes refinancing more expensive
(12:51):
for a New Yorker. So New York loans refinanced slower
than all the other loans. And so what we call
that in the mortgage business call protection. So if for
every basis point decline in rates, a New York loan
is gonna pay a little slower, and that tends to
be advantageous to the investors. So they're gonna take all
If they've got thirty New York loans and thirty Oklahoma loans,
(13:12):
they're not gonna pull them together because that would waste
their money. They're gonna put all the New York loans
in one loan and get a premium for those, and
just sell all of the Oklahoma ones at the at
the kind of generic.
Speaker 3 (13:22):
Right, that's interesting. So if I'm a buyer, I pay
a little bit more for New York loans because of
that less sensitivity the REFI you know, I was thinking,
so again, I'm not trying to get too into my
personal finances, but I remember around twenty twenty three and
mortgage rates hit eight percent, and a lot of things
that people were saying, including like mortgage brokers you call
(13:44):
you on the phone or whatever right after you enter
into some website like oh, don't worry about the high rates.
You just refinanced in a few years. And I you know,
I'm very emh brained. So I'm thinking like, well, if
everyone is already planning on refinancing in a few years,
then there probably is going to be the great refinance opportunity,
because not everyone can just take that free lunch, you know,
(14:05):
when it is eight percent and everyone's like, yeah, I'm
just going to refinance though in a few years, so
it'll be fine. Does that sort of like factor into
the mouth of how much premium the buyer demand?
Speaker 4 (14:15):
Yeah? I think it really did. And let me give
a very specific example. So right now, the spread between
the tenure Treasury and the mortgage rate is relatively large,
and I'm talking about the investor rate and I'm talking
about the actual borrow rate you get at the bank,
right and so there's a lot of discussion as to
why is that right, And it's been pretty sticky. It's
(14:36):
it's stayed unusually wide for a couple of years now,
and I think one of the reasons is what I
would call severe negative convexity. So negative convexity is this
idea I said earlier, where boy, if interest rates rise,
I don't really get any benefit from buying mortgages, but
if instrates fall, I don't get any upside either, right,
So that's this idea of negative vexity. Well, if you
have everybody laser focused on REFI opportunity, right, maybe the
(15:01):
kinds of people who never check on interest rates, right,
but all of a sudden they're like, I'm checking every day.
I want to know the moment if they're laser focused
on that and the moment they have any opportunity, they're
going to be right on it. Right. Well, that's a
different kind of negative condexity. I'm going to take my
bond that I own is going to refive faster than
it might otherwise at a time that people on mayor
(15:22):
may or may not be paying attention. Right. So, as
an investor, you just mentioned your your efficient markets billed. Yeah,
as an investor, I'm not unaware of that. Right, I'm thinking, boy,
these things are going to pay like a bat out
of hell the moment interest rates drop even a little
and I need to get paid a little more for that.
Speaker 3 (15:39):
Tracy. By the way, you and listeners right now should
go to Google Trends and look for a search of
the word no. Seriously is a great charge. Someone had
showed to me this a few.
Speaker 1 (15:49):
Weeks discussing line goes up.
Speaker 3 (15:51):
Look at the word Do a Google Trends search for
the word refinancing, and you will see a big spike
on September eighteenth because it was you know, not everyone's
always paying attention to rates, But there's like one day
this year where the Fed actually made some pretty significant
news that sort of broke through the bubble, and you
could see how suddenly there were a bunch of people
paying attention to rates. Ironically, they didn't get any real
(16:13):
benefits automatically, but you could see how people don't pay attention.
And then there's a day when someday they were.
Speaker 1 (16:19):
The futility of doing Google research. Everyone wants to refile
on that specific date and they can't get a lower
rate anyway. Tom I wanted to ask, what is the
ideal environment to be buying mortgages in because I think
back to the years after two thousand and eight when
interest rates were really low, and I remember big investors
(16:40):
in mbs. They always complained, you know, they didn't want
to get prepaid because then they would have all this
extra money that they would have to reinvest at lower rates.
But now we're in the higher rate environment and they're
also complaining, So like, what is the ideal here?
Speaker 4 (16:57):
Yeah, So one way to think about mortgage investing is
and I'm going to play on another odd lots theme here, please,
It's a little like doing a covered call strategy in
a stock all right. So what I've kind of done
is I bought a bond and I've also sold an
option to the borrower, and that option is to call
(17:17):
my bond away, right. And it's just like if I
buy Microsoft and I sell an option for someone to
buy Microsoft from me. It's exactly the same trade. And
if you think about that trade, right, what you want
is for Microsoft to do nothing, because if it goes down,
I've lost money. If it goes up, I get called away, right,
But if it does nothing, I just collect that premium
(17:37):
and I still have my stock. Right, So what you
want is for interest rates to stay very steady. Okay,
and nobody really gets to refinance. But I don't suffer
the downside that I suffer if interest rates rise, and
so mortgage is it's a tough It can be a
tough total return bond. So like if you think about
someone trying to trade it and play interest rates move around,
(18:00):
that's not that great. What it is is a good
income bond. So I buy it to collect this income.
If interust rates can stay steady, it can be a
great bond to own.
Speaker 1 (18:08):
And this is why people call them pass throughs, right.
Speaker 4 (18:10):
Well, yeah, passive. The other thing people will say is
it can be a good defensive bond. So if you
think that corporate bonds are going to suffer because there's
gonna be a recession, a lot of times people will
rotate into mortgage bonds because they're still yield there and
they're not as sensitive to that part of the cycle.
Usually when that happens, interest rates drop a lot and
you're not getting that upside and so I don't know,
(18:32):
there's a tough space. It's a tough space.
Speaker 3 (18:34):
Do Americans under refinance? I mean there must be some
population that doesn't pay attention. So I'm looking at you know,
mortgage rates in twenty ten, at one point December thirty first,
twenty ten, they're at four point nine to nine percent.
They had gotten as low in twenty sixteen at three
point three percent. You know, I imagine in your covered
call strategy, anyone engaging in these things are very sophisticated
(18:57):
and you call it right away. Is there an advance
for mortgage buyers sort of taking advantage of the fact
that the counterparty to this trade is not watching rates
all day?
Speaker 4 (19:07):
No, for sure, that is true. So this concept in
mortgage trading called burnout, okay, and this is the idea
that at a certain point everyone who's going to refinance
has refinanced. Yeah, So if we rewind to twenty twenty,
twenty twenty one, r ine traates were really low, you'd
still see five percent mortgages outstanding, and you'd be like, well,
why what are they doing?
Speaker 3 (19:26):
Get on life right and not paying attention to an
interest rate right now?
Speaker 4 (19:29):
Sometimes they're just not paying attention. Sometimes they may maybe
something's happened with their credit and they can't get a
lower rate at this point, which you can get a
ton of detail on what the mortgage conditions were when
the bar were initiated the mortgage, but you don't know
that much about where they are in their life now, right.
You just really only know what happened when they applied.
So you can get that. You can also get people
(19:51):
who are thinking about just paying off the loan and
they don't want to restart the clock. So if I've
been in this house for ten years and you're like,
I know, I get a lower rate, but then I
got to reset the clock, maybe a fifteen year more
you do a fifteen year old origion, but maybe that
monthly P and I is too much for me.
Speaker 3 (20:05):
So there's something nice about just paying off a mortgage.
Speaker 4 (20:07):
And accutely, And that's a personal preference. Some people that's
what they want to do. Some people think that's a
bad financial idea, but I think it's up to you.
But anyway, that certainly happens, right, And so it's not
all just not paying attention, but it's not there's an
element of that for sure.
Speaker 1 (20:36):
I want to go back to the spread between mortgage
rates and treasuries, which, as you pointed out, has been
pretty wide in recent years. And I know You mentioned
the negative convexity point, but do you see anything like
structural that's happened in the market that has led to
that bigger spread.
Speaker 4 (20:54):
Yeah, Well, the flat curve they mentioned is part of it, right,
because there's a lot of players. Normally the arbitrage would
be hey, leveraged owners, which could be banks, but could
also be mortgage rates, other hedge funds. Anybody could come
in by the mortgage rate at this relatively high maybe
hedge it with treasuries and borrow in the repo market,
do that whole trade up. But it should work, right,
(21:15):
But if the curve's pretty flat, then you need more
heeld to make it work, and all of a sudden
there's no arm there, right, So I think that's part
of it. I also think the fact that people see
the housing market as a little frozen right as part
of it, right, because there's so many people in one
part in very low rates they're kind of stuck there,
and there's people in very high rates they're kind of
like unable to refinance right now. So I think that's
(21:38):
part of it. I think that earlier I'm going to
go back to my call writing analogy. There's a vix
to the interest rate world. It's called the move index.
You can look at on by your terminal and you
can see that's relatively high. And that plays into how
people think about mortgages because if the volatility of interest
rates is relatively high, then the cost of the option
is relatively high, the cost of the options is relatively
(22:00):
then the mortgage rates can be relatively eye right. So
I think that all plays into it. In my opinion,
the negative convexity bit is the most important one. The
vall bit could improve as we get a little more
clarity on the FED if we stop whipping from oh,
if it's going to do eight cuts, No, they're going
to do two. If we could get into like, okay,
we kind of know the path here, then I think
that voll bit could come down. But and that might
(22:21):
be worth twenty twenty five basis points on the mortgage rate,
But I don't think we're in all the way to
more historic norms of like one hundred and fifty basis
points spread from treasuries to mortgages until we get a
little bit less negative convexity.
Speaker 1 (22:33):
Thank you so much, by the way for tying the
move index to mortgage rates, because I'm actually writing about
it in our newsletter today, the Odd Thoughts Newsletter now.
Speaker 3 (22:42):
Daily Odd Launch newsletter used to be weekly. Go there
and sign up for it.
Speaker 1 (22:46):
Yeah, that was my very eloquent plug for the newsletter. Okay, Tom,
at what point does the spread like get wide enough
that it does entice buyers into the market. Presumably they're
it must be like a level at which it does
become interesting. Or is it the case that it's just
never going to compete with something like, I don't know,
(23:08):
a commercial mortgage or a high yield bond or something
like that.
Speaker 4 (23:12):
Well, you know, I would say at the beginning part
of this year, mortgages became a really popular trade in
the money management business. So I'm just talking about regular
old bond funds. I heard a lot of people talking
up this trade, and the reasons were what you described.
They're like, look, the spreads are really wide. At that time,
we were saying, you know, the Fed's done hiking, maybe
a cut's coming. Maybe that'll cause in straight vault to decline,
(23:36):
So there could be a spread compression opportunity here. I
think there was also an argument that there could be
some risk of corporate spreads widening corporate spreads were really tight,
and so relative to corporate spreads, mortgages were pretty attractive.
And mortgages have performed fine if it's not been a disaster,
but they've underperformed corporate bonds. And I think the problem
has been that this negative convexity issue is interest rates
(23:56):
have dropped, mortgages have just underperformed, and corporate spreads have
keeped tightening. And so money managers have been underweight corporate
bonds for a decade. If you go back and just
look at a soil chart of where general bond funds are,
they've been underweight mortgages forever. So there is an opportunity
for them to come in. But like I think that
started happening and they all got disappointed, and so we'll
see if that continues.
Speaker 3 (24:17):
You know, earlier when you said you're going to touch
on a odd blog see theme, you said the move index.
But I thought you were going to go to the
supply chain aspect, because there is this supply chain right
of mortgages. And I remember that in like summer or
spring of twenty twenty, when interest rates were sent to zero,
(24:37):
that one of the stories that was out there was
that there was so much demand for refin activity that
actually the humans who had to do it, oh where
they were human capital.
Speaker 1 (24:48):
Married under paperwork because there's.
Speaker 3 (24:50):
A lot of paperwork, which also speaking of why people
might not refly like paperwork, it's a really annoying especially
after the Great Financial Crisis, just hundreds of documents. That's
not fun. Can you talk a little bit about the
sort of like the infrastructure of mortgage capacity and how
that's evolved over time?
Speaker 4 (25:07):
Sure, sure, I do. I feel like we're hitting odd last,
that's very real. And what the banks will do is
they'll assess, well, boy, how many mortgages can we process
in a day? Right, and that will help them set
the rate right, because there's no sense in being overly
competitive with your rate if I can't even process right. So, yeah,
(25:28):
so that is that absolutely can be an issue now
right now. The opposite is there there's just not enough
business to be done, right. You just mentioned applications being
so low, and so that probably has resolved in a
little under hiring in the space. Right. Maybe there'st been
a ton of lay offs, but there certainly has not
been a ton of hiring, right, And so maybe maybe
that's just through attrition head councer down in that space.
(25:48):
And so if there is a surprise and in twelve
months mortgage rates are four or some such, we will
absolutely be talking about that. Again.
Speaker 3 (25:55):
Absolutely interesting.
Speaker 1 (25:56):
So I'm going to ask the question that I'm sure
is on everyone's mind per that Google trends chart, but
when do mortgages come down?
Speaker 3 (26:04):
Yeah?
Speaker 4 (26:05):
Or what will it take it?
Speaker 1 (26:06):
Yeah?
Speaker 4 (26:06):
So we should. Let's let's talk about why they've risen
since that FED meeting, and then that I think that'll
inform where they're headed. Right, So, look, the tenure treasury
is not a function of where the FED is today.
It's a function of where people anticipate the FED being
in the next year two, three, right, and beyond three
it's sort of fuzzy, but like you know, year two,
(26:27):
we sort of have a sense, right, we can make
a guess. And so going into that September meeting, people
started thinking themselves, Boy, then my cut fifty basis points
in September, fifty basis points in November, maybe even fifty
more basis points in December. Right, you pull up your
WRP chart on the terminal. You can see this, right
if you go back to then. But since then, what happened.
(26:49):
We got a big jobs report the beginning of October.
That was the September report, but came out October, and
that was kind of a game changer, because not only
did we get a solid number for September, but it
was huge upward revisions kind of erased what looked like
a downward trend in hiring. Right. Well, now all of
a sudden, we're like, boy, the FED might be a
lot closer to that neutral rate than we think. Right,
(27:12):
They're probably gonna still cut in November, but maybe they'll
cut in December. Maybe they won't, but if they do,
it's certainly not gonna be fifty basis points unless something changes.
And so that change in expectations has caused a tenure
to rise, so commensurately the mortgage rate has risen, right,
And so from that store you can say, all right,
well it comes pretty easy to see what's going to
(27:32):
cause mortgage rates to drop. The tenure needs to drop, right,
And what's going to cause the tenure to drop, Well,
we're gonna need more FED cuts priced in. What's going
to cause more FED cuts get priced in? We need
the economy to get weaker.
Speaker 3 (27:44):
By the way, I'm just gonna I'm not gonna pose
this as a question. But another thing that has happened
since September eighteenth is that the odds of Donald Trump
winning have gone up significantly if you look at the
betting market, and there is a widespread view among economists
that thanks to tariffs tax cuts, that could also mean
a reflationary impulse in the economy starting maybe early next year.
(28:07):
So I'm just throwing out there. You know, you mentioned
the jobs report, but policy may get more reflationary after January.
Speaker 4 (28:14):
That I do think that's the consensus view that it's
starting out as it means higher interest rates. Like, we'll
just see if that happens. But I think the key
here is that it's about an anticipation period because even
what you're saying, Joe about potential, you know, change in
physical policy functions, what you're saying, right, that's a big change.
That's an anticipation as well, right, So it's all about
what's being anticipated now, what's happening in real time.
Speaker 3 (28:36):
By the way, Tracy, obviously Tom mentioned people looking forward,
and you know, people, it's funny people are talking about
long and variable legs with monetary policy. But I increasingly
think it should be long and variable leads because rates
have been falling for over a year, well before the
FED formally Yeah about cuts. So there's a sense in
which he's one of my favorite phrases, you know, is
(28:59):
priced in.
Speaker 1 (29:00):
Yeah, markets be four at looking, that's for sure.
Speaker 4 (29:03):
Tom.
Speaker 1 (29:03):
You know, we would be remiss if we didn't ask
a veteran MBS trader and analyst what two thousand and
eight was, like, give us some war stories.
Speaker 4 (29:14):
I mean, I lost a lot of weight, super stressed.
Speaker 3 (29:16):
No, that's great.
Speaker 4 (29:17):
Yeah, yeah, it was the worst reason I've ever had
was What was wild about that time was no one
really knew how deep it could get, right, Like, there
was a lot of assumptions people made, well, I mean,
if this happens, then like, but we also were living it, right.
So when Fanny ma and Freddy Mack were taken over
in the beginning part of September, this was a week
or there's about two weeks I believe before Lehman failed,
(29:40):
which is almost equally as big a deal, but kind
of forgotten to history was Fanny made Freddy Mack were
taken over because they were functionally insolvent and they became
under pressure through early on nine to sell down their
mortgage portfolio. Okay, so at that time, Tracy, you asked
who buys mortgages? Well, at that time I said, well,
Fanny made Freddimac. They're they're number one. So they were
(30:02):
not only guarantee mortgages, but they were a big buyer. Okay,
And is that left the market? Not only was there
just a ton of fear, was lack of capital available
in general, which had this big player who was kind
of gone, right, And so mortgage spreads, the spread we
were talking about between treasuries and with that went through
the roof, right, So and then we had to reassess like, well,
(30:23):
what does this mean if this big player's footprint is gone.
And then of course as they became more of a
permanent war to the state, how they went about guaranteeing mortgages,
what the GFE, how the gfe's worked, all that stuff
got reformed, and so it's been a massive change in
the space for sure. You know.
Speaker 3 (30:41):
Just one last question for me, and again it's sort
of technical, all this paperwork, why can't we just have
like one is it just impossible to imagine that one
click refise whatever exists because of all the credit check
you know, I'm just like used to everything else finance,
like one click move of your account from here to hear,
one click do to this, And I was like, why
does someone offer one click mortgage REFI is just is
(31:02):
it just always going to be too much human capital
intensive for something like that because you've been a great product.
Speaker 4 (31:08):
Yeah, my bet is that regulation makes that hard. Right, So, like,
if you're gonna sell it to fan, we're gonna get
the guarantee. You actually, you actually can get guarantee without
selling the mortgage. But let's say you're gonna get the guarantee,
then you're gonna have to go through Fanny and Freddy's hoops,
which you won't be shocked to know that their computer
systems aren't aren't the greatest. So you always have that right.
And then but the bank itself is going to have
(31:30):
to follow certain regulations even it's going to keep the
loan on book, right, And so I suspect that's that
element makes that difficult. That would be my bet.
Speaker 1 (31:38):
I feel like that's usually the answer to questions about like, well,
why don't we just use technology to make it easier.
It's usually regulation.
Speaker 3 (31:45):
I wonder if there's ever been any like why combinator
startups like we're going to do one click reefise, et cetera,
and then they run into it's like, oh, actually, there's
just a bunch of reasons why this product doesn't exist anyway.
Speaker 1 (31:54):
Yeah, if you've run a failed one click mortgage startup,
let us know and we'll have you on the podcast.
All right, Tom, that was absolutely amazing. You were truly
the perfect guest to talk about high mortgage rates. So
thank you so much for coming on off on.
Speaker 4 (32:09):
Thanks for having me, Joe.
Speaker 1 (32:22):
That was so good to have Tom on talking about
all of this, And I do feel like I understand
it more. It is funny. I mean, I do think
when you think of easing in monetary policy, like one
of the big transmission mechanisms is still supposed to be
mortgage rates. Right. But I think if we've learned one
thing from our current experience, it's that that doesn't always
(32:46):
necessarily pass through. The pass throughs don't pass through.
Speaker 3 (32:50):
Yeah, I would say two things. It's like the pass
throughs don't happen in a very linear, predictable way. There
is nothing that happened on September eighteenth that made everybody's cost.
There are some instruments, you know, short term instruments that
are directly tied to the FED funds rate, but nothing
mechanical happened on September eighteenth that just like made cost
borrowing and everyone new September eighteenth or that a FED
(33:14):
cut was eventually coming as inflation started to roll over
after its peak, and therefore the FED cutting did create
lower rates. It just happened in anticipations cut rather than afterwards.
But it is ironic then that you get that big
surge in people looking for refinance after it was fully
priced in.
Speaker 1 (33:31):
I do like your leading lag idea.
Speaker 3 (33:33):
Thank you.
Speaker 1 (33:34):
You should write about that in the newsletter.
Speaker 3 (33:36):
That's a good idea. Maybe I'll write about it Monday,
our new daily Odd Lots newsletter. Maybe I'll write about
it Monday when this episode comes out.
Speaker 1 (33:43):
Yeah, Okay, I think we've said new daily newsletter enough
on this episode. Shall we leave it there?
Speaker 3 (33:48):
Let's leave it there.
Speaker 1 (33:49):
This has been another edition of the All Thoughts Podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (33:55):
And I'm Jill Wisenthal. You can follow me at The
Stalwart follow Tom Graff. He's at tdgraph. Follow our producers
Carmen Rodriguez at Carmen Erman dash, Ol Bennett at Dashbot
and kill Brooks at Kilbrooks. Thank you to a producer,
Moses Ondem. For more Oddlots content, go to Bloomberg dot
com slash Odloffere have transcripts, a blog, and a new
(34:16):
daily newsletter.
Speaker 1 (34:17):
And if you enjoy Odd Lots, if you like it
when we dive into the math behind mortgage rates, then
please leave us a positive review on your favorite podcast platform.
And remember, if you are a Bloomberg subscriber, in addition
to getting our new daily newsletter, you can also listen
to all of our episodes absolutely add free. All you
(34:38):
need to do is find the Bloomberg channel on Apple
Podcasts and then follow the instructions there. Thanks for listening.
Hosts And Creators
Joe Weisenthal
Tracy Alloway
Popular Podcasts
Stuff You Should Know
If you've ever wanted to know about champagne, satanism, the Stonewall Uprising, chaos theory, LSD, El Nino, true crime and Rosa Parks, then look no further. Josh and Chuck have you covered.
Dateline NBC
Current and classic episodes, featuring compelling true-crime mysteries, powerful documentaries and in-depth investigations. Follow now to get the latest episodes of Dateline NBC completely free, or subscribe to Dateline Premium for ad-free listening and exclusive bonus content: DatelinePremium.com
The Herd with Colin Cowherd
The Herd with Colin Cowherd is a thought-provoking, opinionated, and topic-driven journey through the top sports stories of the day.