My Mortgage Blog

With Gadaffi shouting and shooting at his own population, with street protests all over the world, with the price of a barrel of crude at about $102 and gasoline at budget-bruising highs at the pump, does it seem like a likely time for interest rates to rise? This is all very difficult for most consumers to understand…and usually less than crystal-clear to the rests of us.

The point of this little article, therefore, is simply to remind you constantly to explain to your clients how and why Treasury securities rise and fall. If you can do so, and if they then have an experience of being able to predict (or, at least, understand somewhat) the seemingly inexplicable moves of rates, you will have a trusting client working with you. And that translates into more business, and more satisfying relationships.

Why, for example, did Treasury rates rise a bit on Wednesday afternoon?

It turns out that the Fed issued a “beige book” report in which it asserted that the overall economy continues to improve as we move into 2011. Even with dramatically higher fuel prices, the Fed insists that inflation remains benign. The higher prices, after all, could change in a day. They are not based on oil market fundamentals; they arise from today’s tumultuous and constantly changing political problems that have broken out all over the world.

Still, there are concerns that manufacturers and retailers may not be able to continue passing the higher costs of oil and other commodities to their customers, especially as fuel and commodity prices remain so much higher than in the recent past. There is also concern that consumers’ retail purchases will be minimized greatly by the added expense of gasoline and other basic (like food).

But there it is. Treasury security yields rise when it appears that the economy is doing well. They rise precisely because the markets fear a sustainably improvement economy is the harbinger of higher inflation. When the economy stumbles a bit and appears to need some support, Treasury security yields tend to decline—to help the economy rebuild its strength.

Now, this all seems rather counterintuitive to most consumers…but Treasury yields ARE counterintuitive. If the value of an existing security rises, that is because market yields for that security have fallen. This is a formula most of us need to remind ourselves of whenever rates rise or fall.

Bottom line, it’s rather simple. Buy $10,000 face value of 10-year notes. Let’s say those notes bear a yield of 3.45% when you buy them, meaning you’ll receive 3.45% as the notes are repaid, along with your original investment. Let’s say the market changes, as it does incessantly, and 10-year notes are now worth 3.35%. Your existing notes bearing a 3.45% yield then become slightly more valuable because they will return a higher rate of interest than today’s T-notes.

Thus, lower yield means higher value for Treasury securities. And vice versa. In some abstract realm of the brain, it makes perfect sense, though most of us have to stop and think it through all over again. The $10,000 face amount is a value that never changes. Only the yield changes, and it moves the value up and down that you can receive if you resell your Treasury securities on the open market. (If you hold your Treasury securities to maturity, you can forget this complex file gumbo.)

This is very old news to most readers of this column. What is not old news is the act of explaining it to clients who are still a bit wet behind the ears. I hope this helps a bit. And I’ll be back next Monday. Meantime, with no confidence in the stability of world markets, I admit I’d be inclined to lock in the best-looking rate I find over the coming week. We are tip-toeing through economic minefields and the word, “inflation,” is being mentioned with increasing frequency.