Written by Robert H. Ruth
Remember the movie the Karate Kid? The young man’s instructor, Mr. Miyagi, teaches Daniel discipline with his phrase “wax on, wax off.” To paraphrase that, in the financial markets, there is a phrase that is popular called: “ Risk On, Risk Off ”, and that phrase is a good way to think about how financial market movements impact rates. Let me explain:
- The stock market moves constantly; it ebbs and flows
- When the stock market moves up, it means that people or institutions are actively buying stocks, and the volume is driving the price of stocks upwards.This has been happening in dramatic fashion since the election in November. The financial markets like the message that President Trump is sending with his promise to relax excessive regulations on American banks and businesses, and grow the economy at a faster pace.
- When you buy a stock, you are purchasing equity ownership in a corporation, and that gives you voting rights in the corporation along with dividends paid if the company continues to prosper.
When the market is moving up, people feel optimistic that stocks are the best place to put their money, where they will get the highest return, and their confidence in the market outweighs the potential risks of investing.
- The bond market also ebbs and flows .
- But where stocks are a way for investors to have equity (ownership) in a company, a bond is essentially a debt instrument.
- Companies often need more capital than they can access alone to expand their businesses, and governments need money to repair infrastructure, pay for highways and schools, and fund social programs. So the bond market is where is where companies or governments go to get investors to help them raise money. When you buy a bond, you give the issuer of the bond a loan, and they will pay you back the face value of the loan at a specific future date (called maturity) plus regular interest payments until the bond matures.
Since bonds are backed by governments and large institutions, and because promise to return your principal at maturity they are considered a safer investment. Put differently, there is less volatility in bonds versus stocks.
Risk On / Risk Off
When stocks are doing well, bonds do less well. That is because bonds pay a lower return on capital, so people and institutions will pull money out of the bond market to invest in stocks, and when the stock market sells off, investors move their money out of stocks and into bonds, which they perceive to be a safe haven for their money. And one of the safest havens are US Treasury Securities, and the most important of these as it relates to Home Mortgage Rates, is the 10 Year Treasury Note.
Next week, I’ll focus on the 10 Year Treasury Note, how it impacts mortgage rates, and how you can track it, which will give you a strong insight into the direction of interest rates