How a Strengthening Dollar Improves Mortgage Rates

by Florida's #1 Mortgage Planner on September 4, 2008

With the US Dollar growing stronger these days, there are several ways in which it helps to lower mortgage rates in Florida, and nationwide. 

The more obvious is that a stronger dollar helps drive the prices of commodities down, such as oil and food.  Since mortgage bonds, aka mortgage backed securities (MBS), are traded on the open market and they hate inflation, lower prices on these commodities helps to reduce inflationary expectations, and thus, helps lower mortgage rates.

A lesser thought of factor in lowering mortgage rates is increased demand by foreigners in our bond market.  We have seen foreign demand reduced as the dollar weakened and the mortgage meltdown occurred, but recent Treasury auctions have seen higher participation levels. 

Why would foreigners want to buy or Treasuries and bonds in times like these?

The strengthening of the dollar is a big reason.  To fully understand this fact, you have to understand the foreign exchange rates and their effect on rates of return.

You see, if you are a foreigner and invested in the US when the dollar was devaluing, if you could get a 6% yield on our mortgage bonds, the net rate of return for you would actually be lower, meaning it would not be as good of an investment. 

To demonstrate, let’s take that 6% yield and say that you had a $1.00 (USD vs yours) exchange rate.  That means that for every dollar you spend, it would cost you the same in your currency, say the Loonie (Canadian Dollar).  These are not the current exchange rates, merely for this example. 

Now, let’s say 1 year down the road, the exchange rate went to $1.50, meaning it costs $1.50 for every one of your currency, that is a 50% loss of value in the USD, which we have seen over time.  That means that your yield has just lost half its value, or just became 3% to you, versus the 6% yield in USD. 

Now, flip the side to a strengthening dollar and look at the same example.  While the 6% yield in USD remains the same for both examples, if the exchange rate were to go to $.50, that would mean your rate of return would be dramatically different, in fact it would have doubled to 12%. 

I hope this has showed the impact of a strengthening dollar as one of  the reasons that there is increased demand for our mortgage bonds, which send prices higher and yields lower.  The lower yields equate to lower mortgage rates.

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