By Ryan Casey Stephens, FPQP®
Special Contributor
As you drove your car today, how much time did you spend glancing at your rearview mirror? Did you know that driving experts suggest looking up at your rearview mirror every 5 to 8 seconds? That means on an average 30-minute drive, you might look behind you as many as 360 times.
Now, imagine that same drive, but spending nearly the entire time looking into that rearview mirror. I don’t suggest trying it on the way home, but if you were to do that you’d have a better idea of precisely what the Fed sees when they’re trying to determine our national monetary policy. This week we’ll get two important inflation reports and the Fed will again use data from the past to decide the future. What will they do, and how will markets react? We’ll cover it all in this week’s Three Things to Know.
This Only Goes Two Ways
Our first major event of the week occurs Wednesday morning when we receive the latest CPI inflation data. There are two key components to the data: the headline figure and the core number. The key difference between the two is that the core strips out food and energy prices. That makes the core number the Fed’s preferred in this report because they don’t control the prices of those two components.
It’s difficult to predict how markets and the Fed are likely to react. First, the core figure is likely to worsen slightly. That leaves the door wide open for pundits in the media to rage about another month of increasing inflation. On the flip side, the headline number has the potential to improve. At the moment there’s a nearly 70 percent chance of a .25 basis point Fed rate hike at their next meeting. Will Wall Street see the lower headline inflation and expect a Fed rate pause, or will they look to the worsened core figure and demand a bigger hike to combat inflation?
First Thing to Know:
It’s anyone’s guess which piece of the CPI report will get all the headlines tomorrow, but most lenders will be preparing for the worst. If the focus is placed on a core figure that has the potential to look negative, we might see mortgage rates temporarily increase.
More Rearview Mirror Context Will Clarify
While not one of the Fed’s favorite measures of inflation, the PPI report will come in the following day and will likely provide some much-needed context. This report is interesting because it measures the change in prices paid to the producers who create goods, versus measuring what consumers pay for those goods.
Another important difference between Wednesday’s CPI and Thursday’s PPI is that the latter doesn’t take housing inflation into account. We believe lower shelter cost numbers are coming that will help the CPI this summer, but not yet. That means that this week at least, the PPI might provide us with a more accurate measure of where we stand with real inflation. In the best-case scenario, the headline CPI on Wednesday and the PPI on Thursday both point to cooler inflation, which would be quite positive for mortgage bonds.
Second Thing to Know:
In the best-case scenario, the headline CPI and the PPI reports show cooling inflation and the mortgage industry has a chance of continuing the recent trend of dropping mortgage rates.
Vocabulary Term: LLPA
Agents, have you ever asked your preferred lender how conventional loan rates are determined? It’s true that lenders have some discretion to charge more or less margin based on their budget needs, but did you know a massive portion of the rate is actually determined by Fannie Mae and Freddie Mac? By adding Loan-Level Price Adjustors based on things like credit score, loan type, down payment, and other loan features, Fannie and Freddie create vastly different pricing on a loan-by-loan basis. If you’re a glutton for punishment, you can actually access these grids online to see exactly how much rate is added for each variable involved in qualifying for a mortgage.
Why is this newsworthy? Well, Fannie and Freddie rolled out massive overhauls to these LLPAs in the last month or so, and one was so controversial they actually delayed its implementation. I experienced a glaring example of the changes this week and thought I’d share. A husband and wife are buying a $500,000 home and putting 20 percent down. Both have credit scores in the mid-700s, and their scores are only 30 points apart. However, the husband’s score fell 3 points under the cutoff for one of these LLPAs. If I keep him on the loan, their interest rate is 7.125 percent. If I remove him, they see a massive benefit — a 6.625 percent rate. Just to reiterate again, two borrowers, both scores in the 700s, and a radical difference in rate and payment.
Third Thing to Know:
Agents, have conversations about these LLPAs with your clients. Make them aware that the rates they see online can be deceptive, because with the changes made by Fannie and Freddie, two very similar borrowers can see widely different interest rates for the same loan.
Ryan Casey Stephens FPQP® is a mortgage banker with Watermark Capital. You can reach him at [email protected].
