Rates Creep Up; Is Hedging a Factor?

In recent weeks, long-term mortgage rates have edged up to their highest level in several months (though they remain low by historical standards).

In early June, Freddie Mac reported that the average rate on 30-year conforming loans was 6.09%. That's still nearly half a percentage point higher than it was a year ago. The 30-year average is now at its highest point in about three months.

The good news for people who manage interest rate risk is that long-term rates have been relatively stable in recent weeks and months. But many economists seem to think that the risks are largely concentrated on the upside due to inflationary concerns.

Frank Nothaft, Freddie Mac's chief economist, said in a commentary that while the economy grew at a faster rate in the first quarter than originally projected, consumer spending rose only 1%, the smallest increase seen since the 2001 recession.

"In addition, the core price deflator was revised downward to an annualized rate of 2.1% and remained at that pace in April, but that is still above the Federal Reserve's stated comfort zone," he wrote.

With rates creeping up, refinancing has slackened a bit. The Mortgage Bankers Association reported that refinancing accounted for 41% of home loan applications in the last week of May, after hovering at or near 50% for a number of weeks. That marked a 25% decrease in the MBA's refinancing index, which measures activity compared to a base level.

The upward creep in rates perhaps lets servicers breathe a slight sigh of relief, while it is modest enough that it shouldn't cause too much alarm among originators. Still, in a changing economy, it raises questions about what moves interest rates.

Inflationary concerns seem to be the cause of the recent upward tick in rates, but not that long ago some experts were questioning whether or not interest rate hedging itself was a factor in rate movements. That question is still open today.

In 2005, Freddie Mac economists produced a paper that looked into the question of whether or not hedging by mortgage market participants might be "amplifying" interest rate volatility. Their conclusion, based on historical data, is that mortgage industry hedging had a stabilizing influence on interest rate volatility during some periods, while it exacerbated volatility during other periods.

Dropping periods that were associated with the long-term capital management crisis and the 9/11 terrorist attacks, Freddie Mac concluded that there is little impact on interest rate volatility from hedging.

In short, "no simple relationship between hedging and rate volatility is implied," the Freddie Mac report said.

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