EVERYONE HAS BEEN EXPECTING INTEREST RATES TO INCREASE for many months now, so why did they take a sharp turn down over the last couple of weeks? And where are they headed next?

Interest rates are tied to the global economy. The Federal Reserve loosens the money supply to keep rates low and tightens the supply when it wants to raise them. For many years this has worked well and the Fed has been able to moderate rates according to economic conditions.

Then our economy became more global in nature. Now when there is a crisis in Europe or the Middle East, our economy can be impacted and interest rates in the U.S. can swing up or down based on those global conditions.

To state the obvious, investors seek the greatest returns possible on their investments. They don’t want to lose money, so they desire to take measured risks. Common wisdom is that investing in companies, i.e. buying stocks, results in greater returns than when investing in money, i.e. investing in bonds.

However, investing in companies can be pretty risky. Uncertainty in the economy tends to increase that risk. The U.S. stock market has been on a tear for several years now, reaching record highs. As the markets reach higher and higher, more folks have been getting nervous, believing that the market has overreached and calling for a “correction.”

In an environment where many expect the value of stocks to fall (some say dramatically), it doesn’t take much to push the scales and cause a significant drop. Over the last couple of weeks as the market lost value day after day, investors became less and less confident that their values would hold, and more of them trimmed their portfolios of stocks.

I get updates on the markets throughout the day. On a normal day I probably get five emails and a couple of text messages. I also receive daily rates in the morning that stay the same throughout the day. But at the peak of the frenzy last week I was receiving as many as 20 emails and text messages at least every hour throughout the trading day. I think on one day last week, I received repricing alerts four times, improving rates and increasing rates, finishing the day just a little down from where rates started in the morning.

Interest rates today can be explained as simply as the law of supply and demand. When investors around the globe become nervous, they seek out safe investments. Mortgage-backed securities, backed by the U.S. government, and other similarly backed investments like Treasury bonds become “safe haven” investments. When demand for these investments rise, the value of bonds increases — and the result is lower interest rates.

Rates have unexpectedly dropped because investors are less confident in the economy and are buying bonds as a hedge against losses. Will this continue? Well, that is anybody’s guess. But I would like to think we will see the markets stabilize.

Guy Benjamin (CAL BRE License #01014834, NMLS 887909) writes a weekly column for The Herald, offering general information on real estate matters. As it is impossible to address all possibilities and variations, he will try to answer individual questions by readers who contact him at 707-246-0949 or guyb@fairwaymc.com.

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