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Economic gloom and doom is good for homebuyers

30-yr fixed rate mortgages—whether for conforming loans or jumbos—have now fallen to their lowest levels ever. One of the main drivers of lower mortgage rates is the flattening of the yield curve (the 2-10 spread is down to 230 bps from a recent high of 290), that in turn is being driven mostly by declining bond yields. Lower bond yields are apparently the result of the market's recent conviction that a weakening economy will keep the Fed on hold for a very long time; the prospect of an extended period of very low short-term interest rates creates a very painful situation for anyone who has been betting on higher bond yields and a steeper yield curve because that trade has a significant cost of carry (i.e., the difference between short and long rates). So we have the perception of a weak economy to thank for giving us lower bond yields.

This presents a real opportunity for millions of homeowners to lock in some very attractive long-term financing. Not surprisingly, record-low mortgage rates have caused refinancing activity to surge, and refis are likely to be quite strong in coming weeks. (Even I am looking to refinance.) Locking in historically low rates of interest is surely a good thing, but it is also important to see that homeowners continue to respond to the incentive of price signals. Cheap mortgages coupled with the one-third drop in inflation-adjusted housing prices over the past several years (according to the Case-Shiller data) have made the average house a lot more affordable than it has been in decades. This is a powerful incentive for new buyers to bid for all of the foreclosed houses that are supposedly going to be dumped on the market over the course of the next year. I think it's premature to expect that there will be another big drop in prices, as so many seem to be predicting.

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