05 February 2025

Whew, in the light of what has been an incredibly eventful start for markets in 2025, I’m going to choose my top three topics this week to break down into further detail.

1. AI Helping Mortgage Rates: Investors Sought Safety in Bonds after Deepseek Surprise

Does it seem to anyone else like this event took place already lifetime ago? LOL. No, it turns out it was only beginning of last week that the stock market was absolutely rocked on news of a new kid on the AI block, Deepseek. The story goes that DeepSeek was built much faster than ChatGPT, cost much less, and is just as good. This made investors fear that domestic AI stocks might be overvalued. As a result, money fled the stock market and thankfully much of it found a home in bonds, thus helping long-term rates move lower.

   2. A Historical Look at 2019 Trade War & its Impacts on Mortgage Interest Rates

Even as I write this paragraph, it’s possible the Trump Administration’s strategy regarding possible implementation of trade tariffs on foreign countries has updated again, so I’m choosing not to provide real-time updates on this issue until the dust settles and we have a clearer picture moving forward.

So instead, I’m going to briefly review some impacts of the 2019 trade war and more specifically, how it eventually impacted long-term interest rates.  Please note this may not be a relevant historical example as this time we are bringing Canada and Mexico into the equation, and we can all acknowledge this is a very different economy, and very different political climate. But alas, the data shown here is interesting.

The 2019 tariff-driven trade war between the US and China led to some economic malaise, and did not create a noticeable increase in inflation. Traders in 2019 had initially pushed rates up as they braced for the impact from tariffs and the tax bill, but It ultimately resulted in long-term rates moving lower due to some economic fallout related to these policies.

This time could be different, but we won’t really know until we see the specifics and have some track record of actual impacts showing up in real-time economic data. It’s somewhat safe to assume based on this historical data that if economic fallout from a future trade war outweighs the inflationary impulse, we would see long-term rates move lower in response to tariffs.

  3. Expect Inflation Data to Continue to Inform All Long-Term Rate Market Movements

A chart of year-over-year inflation makes it clear just how much we’ve paused on the way back to the 2.0% target. To be fair, this line should move lower simply because higher inflation readings from 11-12 months ago will soon be falling out of the 12-month analysis.

Even so, this is not the annual chart the Fed was hoping to see when it began considering rate cuts in the middle of 2024.

Rates were helped again this week by ISM Services index coming in lower than expected (52.8 vs 54.3 forecast) and ISM Prices Index (60.4 vs 64.4 previously). The ISM stands for Institute of Supply Management, which is a non-profit organization responsible for measuring Purchasing Manager’s Index or PMI for both the manufacturing and non-manufacturing industries in the United States.

Let’s look at 30YR UMBS 5.5 (Mortgage-Backed Securities) trading chart through today. The red arrow shows significant gain in yields starting from lows January 13, 2025 (remember this equates to lower long-term interest rates) through today February 5, 2025.

While markets will undoubtedly bounce back and forth in response to “a lot going on at the moment”, the largest indicator of whether we’ll be able to hold the line here on interest rates will be inflation data to be released over the coming days and weeks.

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