Have fixed rates hit rock bottom?

It’s been a long time since swap rates – money market rates that influence the cost of mortgages – have been worth talking about, but the last couple of weeks have seen 5-year rates jumping significantly. Only at the start of May 5-year money was comfortably below 1%, but are now knocking on 1.5%.

They’ve actually been drifting upwards for a while, and have doubled since the trough of Q4 last year, but have taken off like a rocket in the last week or so. 2-year rates have been climbing too, though not quite as dramatically. Here’s the last 3 weeks worth:

So what’s behind it and what does it mean?

There’s nothing hugely obvious in the domestic economy, though we always need to be mindful of the fact that these markets are largely confidence-driven, and it’s entirely possible that a chunk of this is simply correcting a degree of over-optimism when the Euro crisis settled down.

On the other side of the confidence coin, an article in the FT  (registration needed) and a piece on this morning’s Today programme reference concerns about the US possibly easing their $85bn per month money-printing. Markets getting antsy, in other words, which tends to push rates upwards.

Giving a lucid explanation of how the mere thought of less QE in the US can drive up bond and swap rates here – and indeed potentially destabilise the Euro all over again – isn’t easy. Happily, Robert Peston has already done it.

Combining the two – less optimism on one hand and perhaps excessive pessimism on the other – we might tentatively forecast that swap rates will peak fairly soon and perhaps start drifting downwards again, though probably not to their late 2012 trough.

And what does that matter to us? It’s been an age since mortgage rates could be closely linked to Swap behaviour, and we have the added complication of cheap Funding for Lending money subsidising lenders. Nonetheless swap rate trends are still the basic underpinning of fixed rates and if we saw the 5-year rates stabilise around, say, 1.25% or so that would still be 0.2%-0.3% higher than in May, and a good 50-60bps above last year’s low point.

That kind of increase in wholesale funding can’t be tolerated forever, and we’ve heard a couple of lenders indicate they’ll struggle to maintain pricing at this level – even in the face of increased appetite and cheap FLS cash. So it wouldn’t be all that surprising to see fixed rates start to nudge upwards.

It won’t happen all at once and we may well see a few more bids for the meaningless but headline-grabbing “lowest-ever rate” tag, but come August or September we may be looking back on today as the golden age of the fixed rate.

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