Markets do the Safety Dance

July 26, 2021

Last Week in Review: Markets do the Safety Dance

Last week’s long-term rates and home loans rates touched the lowest levels since early February mainly due to rising concerns over the Delta variant of COVID causing more restrictions, shutdowns, and a slowing economy in the future. Let’s talk about what this “safe-haven” trade into the bond market means and what to look for in the days and weeks ahead.

Safe-Haven Trade Explained

During times of high uncertainty around the globe, much like we saw this week with Delta variant fears, we see what is called a “safe-haven” trade. This is where money flows into the safety of the U.S. Dollar and dollar-denominated assets like Treasury and mortgage-backed securities (MBSs), all at the expense of stocks that are deemed risky.

This past Monday, we watched the Dow Jones Industrial Average fall over 700 points, while both Treasury and MBS prices jumped as the safe-haven trade was on.

What Happened?

By midweek long-term rates ticked higher, erasing all the fear. Markets tend to overshoot both to the upside and downside, so by Tuesday, when “cooler heads”prevailed, stocks rallied sharply, erasing all their Monday losses at the expense of bonds and rates.

The reality is that the economy continues to improve, albeit more slowly, but it also means the Fed is not likely to make changes to interest rates or its bond purchase program anytime soon. If rates stay low and the Fed is not changing course, then it’s always a reason for stocks to party and move higher.

On top of the Fed, the Administration is about to embark on another several trillion dollars in spending, intending to boost economic activity.

Now we can only hope and pray the fears surrounding the new Delta variant come to pass. For now, the markets’ fears have been short-lived. We will get a better sense of reality in the weeks ahead as the U.K. just lifted all their COVID restrictions.

Inflation’s Role

For the past couple of months, consumer prices (inflation) have run above 30-year mortgage rates for the first time in 50 years. This is the definition of unsustainable. At some point, either inflation must come down a lot, mortgage rates must rise, or a combination of both.

It’s no wonder the Fed is buying MBSs. Who in their right mind would purchase MBSs when the interest received is not even outpacing inflation?

The Time Is Now

Could rates go lower? Sure. For that to happen, it would likely take something very bad, like a COVID-induced economic stall becoming reality. The markets are not pricing in that scenario right now.

Next, the Fed is under pressure to start tapering their MBS purchases. It may not happen for some time, but when the Fed announces their intention to do so, home loan rates will move higher in a hurry, and today’s rates will be in the rear-view mirror.

Bottom Line: For the reasons mentioned, this is an incredible interest rate opportunity.

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