Catching a Falling Dagger, Part II: Predicting Future Interest Rates

You can read what I said in Part 1, which considered how to estimate future real estate values as a way of buying at the lowest price. The same is true of trying to judge interest rates. Getting the very lowest rate of the year is like trying to catch a falling dagger — it's treacherous business.

This topic is worthy of some further discussion because my experience is that the most unlikely people – real amateurs – seem to feel that they are most adept at predicting interest rates. In fact, they are inept and are most often wrong! Let's see why.

It is now January 2009 and we are seeing interest rates that are at 35 year lows. I have recently locked in 30-year loans at 4.75% and 15 year loans at 4.5%. Obviously these rates are attractive to purchasers, but the rates also bring into play many people with interest rates on current loans that are in the 5% and 6% range. If they are going to be in their homes for a while, it makes sense for many of them to refinance.

But whatever the rates are today, for some people it seems as if it's never quite good enough. If the rate is 5%, they want 4.875%. If it's 4.875%, they want 4.75%. I suppose that if the rates went to 3%, highly unlikely in my view, they would want 2.75%. They never seem satisfied with whatever the rates are today.

Here are my rules about interest rates and locking.

1. You can't have yesterday's rate.
2. If you want tomorrow's rate, you have to wait until tomorrow.

And the biggest one of all:

3. YOU CANNOT PREDICT THE FUTURE!

If this sounds simple, it's because reality is often simple. For me it is important to help people. People like me work to get borrowers the best deal, but sometimes they get in the way, tripping over their own feet. And it's all so unnecessary, because their frustrations are due to their inability to reconcile the rules above to their own situations.

Let's see how hard this is. For example, I keep track of the yield on the 10-year Treasury Bond because it is highly correlated with fixed-rate mortgage rates. Here is the chart for the first few weeks in January 2008. Let's assume that you look at these same numbers daily because you want to lock in when rates get to the lowest point. This looks pretty good, doesn't it? You can either lock today or wait until tomorrow hoping the trend continues. What will it be? Today or tomorrow? Place your bet.

10-Year Treasury Bond Yield: January 2008

Oops! This was a trap. The 23rd WAS the lowest point. On the 24th the yield was 3.64% and it finally topped out on February 20th at 3.91%. So if you said, "Tomorrow," you lost.

Rates stayed in that range and finally bottomed out on a chart that looked a lot like this in late March with a yield of 3.314%. But that lasted only for a couple of days. They topped out at 4.245% on June 16th and didn't get back below 3.5% for three months, until mid-September, and then, again, only for a few days.

Now that brings us up to the present. Starting in mid-November rates fell even more and then really fell in December. Here's what the chart looks like for December 2008:

10-Year Treasury Bond Yield: December 2008

Darn! That looks pretty good. Mortgage rates are below 5% and refinance activity is surging. So you now have an opportunity to lock. Shall we do it today or wait for another few weeks and risk that rates will go up? Place your bets.

I hope you said, "Lock today!" because this was another trap! The Dow staged a 250 point rise, ending above 9,000 at the very beginning of 2009, and the yield on the 10-year Bond jumped to 2.416%, a jump of almost 3/8ths of a percent! If you said tomorrow, you are either going to pay more or wait until the next bottom. The problem is that you won't be any better at recognizing the next one as you were with the last ones.

I have given you some real numbers here because I want you to understand how difficult it is to predict the future. If you feel a little abused by this little lesson, welcome to the real world. I just want to make sure you have your head screwed on properly. Tens of thousands of people on Wall Street do this for a living and they aren't any better at it than you are. They did NOT make their fortunes and STILL need to work for a living.

When it comes time to refinance, look at a chart like this, get your application in, go through the numbers with your loan officer, and see how much money you will save if you lock in at today's rate. If the numbers make sense, do it. Don't think that the market will act in your favor because you are someone special. The market does not even know you exist. So get your application in before the window closes on these great rates!