Why Money Left Stocks And Got Picky About Bonds

This graphic from the Wall Street Journal shows last week's losses across a few of the world's major stock markets.

Money leaving stocks has to go somewhere and investors have two choices:

• Hold the money as cash
• Invest the money in bonds

Usually, investors don't want to be on the sidelines.  So, they will often take the proceeds of a stock sale and use it to purchase bonds.

Remember that mortgage rates are the by-product of prices and yields in the mortgage-backed securities market.  When demand for bonds increase, it drives up the price and drives down the yields.

This is why rapid stock sell-offs often lead to lower mortgage rates.

This past week was a little bit different, though. 

Despite the worldwide losses, mortgage rates decreased only about 0.04% on average, according to Freddie Mac's weekly survey.

The benchmark 10-year treasury note, however, dropped 0.165%.  This is the biggest gain in over five months for the treasury market.

Investors chose to park their money with the U.S. government last week and that reminds us that one very important fact about the oft-confused bond markets:

U.S. treasuries and MBS tend to move in the same direction, but treasuries cannot be used as a predictor of mortgage rates, nor can they be used to price mortgage loans.  Only the mortgage-backed securities market can be used to price mortgages.

One major reason why treasuries excelled while MBS markets laid flat is because investors are concerned that sub-prime lending's carnage will spill over into other mortgage markets.  That renders mortgage-backed bonds much more risky than in weeks and months prior and, in a period of volatility and uncertainty, the markets turned to Washington D.C. for safety.

Source
Out of Stocks, And Into...?
E.S. Browning
Wall Street Journal Online, March 5, 2007
http://online.wsj.com/article/SB117304961563826411.html?mod=home_whats_news_us