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photo © 2010 Tedd Santana | more info (via: Wylio)Mortgage rates in the Bay Area and elsewhere have been on a pretty wild run higher over the last several weeks. We’ve seen a few big jumps happen all in a string, not something we see too often without some corrections along the way.

That this has happened in the face of an economy that continues to struggle in general, and with unemployment and deflation concerns and no clear path to recovery, has kept many of the mortgage market analysts and commentators adequately confused as well.

It’s been like watching a kid on the beach running away from a wave as it rolls up on shore, and finally getting their feet wet. Or in this case, maybe the wave kind of overcame them and knocked them down, got them soaked. And just before being dragged out to sea, the commentary from the analysts has changed in the last day or two from one that was generally defiant, to surrender.

I mean no disrespect here. I know that nobody is capable of predicting the markets. But I look for a variety of opinions, because that gives perspective on the events that impact markets as they unfold, and helps frame conversations for me with my clients. Thats why there are people getting paid to analyze and forecast. And that’s why I read, watch and listen. Ever since Quantitative Easing II was announced by The Federal Reserve, the bond market has been retreating, and the analyst consensus has been pretty heavily oriented toward disbelief, and an expectation that it would come back around most, if not all the way. After all, that was the whole point behind QEII.

Then on Monday, two days ago, we got the first day of what looked like a correction, to bring the rising rate trend to a halt, maybe send it back the other way. It was triggered by an episode of 60 Minutes, where Fed Chairman Ben Bernanke reiterated that he believes our economy is fragile, and stated that he expected unemployment to be elevated for several (4-5) more years. This gave all the collectively defiant analysis the reinforcement it thought it needed to once again remind that this too shall pass.

Until yesterday. The consensus changed quickly. Triggered by tax cut extensions and unemployment benefit extensions, which happened over night. Look at some of the snippets I’ve gathered over the last two days:

Yesterday: The equity market is rallying and the bond market getting hit; that the deficit will increase by $700B is a death knell in the bond and mortgage markets for lower interest rates, in the minds of many it clearly shows that Washington is still paying only lip service to deficit reduction. That is the knee jerk reaction and in an already bearish rate market it doesn’t take much to add selling of fixed income investments. <$700B being a reference to the expected shortfall to the US Treasury due to tax cut extensions…>

Today: Very unusual that there seems to be no one stepping up to try and put some reasoning behind the spike in rates. It is as if it is happening with shock and awe, no consensus or any particular explanation.

Yesterday: With the way the market is reacting to goods news compared to bad news, I would suggest if you are not already doing this, to lock when your deal is approved until this madness stops. Changing advice from float to lock.

Today: Lock (no comments)

Yesterday: Not sure current level of support is strong enough and if we dont hold, we will fall hard in search of new lows.  Ouch.

Today: We are in a free fall until bottom can be found

As I was writing this, the bond market seemed to have hit a bottom. The day isn’t over yet, but it bounced, and has started to recover. Nowhere close to erasing yesterday’s move, but no longer looking so much like a free fall. We’ll see… There’s always tomorrow. Or later today. But either way, it struck me as a good time to revisit the Investor Emotion Cycle (chart). When everybody starts thinking the same way, look out.

It can be tough to evaluate your own circumstances when the targets are moving this quickly. But if we’ve seen the bottom in rates, and are in fact headed to a new range, it’s going to stir up quite a few issues for people with adjustable rates, or who had been waiting for something else to fall into place. Sound like you? Let’s talk about it. Contact me below, and let me know what’s up.

I love the parable offered by David Kotok at Cumberland Advisors in a recent market commentary, a link to which you will find below.

“My Big, Fat, Never on Sundays Story.”

It is the month of February, on the shores of the Adriatic Sea. It is gray and raining. The little Greek town looks totally deserted.

It has been many months of tough times; everybody is in debt and everybody lives on credit. The government has run out of money and the unions are constantly striking but getting nothing because there is nothing left to be gotten.

Suddenly, a rich German tourist comes to the village. He enters the town’s only hotel, lays a 100 euro note on the reception counter, and goes upstairs to inspect the rooms in order to pick one.

The hotel proprietor takes the 100 euro note and runs to pay his debt to the butcher.

The butcher takes the 100 euro note and runs to pay his debt to the pig grower.

The pig grower takes the 100 euro note and runs to pay his debt to the supplier of his feed and fuel.

The supplier of feed and fuel takes the 100 euro note and runs to pay his debt to the town’s prostitute, who, in these hard times, provided her services on credit.

She runs to the hotel to pay for the rooms she rented on credit when she brought her clients there. She hands the proprietor the 100 euro note.

He lays the note back on the reception counter so that the rich tourist will not suspect anything.

A minute later, the wealthy German comes down the stairs, announces he did not like any of the rooms, puts the 100 in his pocket, gets into his Mercedes, and drives away.

There were six financial transactions. No one earned anything. Nothing was added to GDP. However, the whole town’s debt-GDP ratio changed dramatically. The village folks are now out of debt and look to the future with a lot of optimism.

Oh, if it were only so easy?

You can see more context to this in the commentary piece, and also other fantastic coverage of the sovereign debt issues, and whatever else may be going on in the market at the given moment at the Cumberland Advisors website.

The NY Federal Reserve is, and has been, the biggest buyer of Mortgage-Backed Securities for all of 2009. This helps push mortgage rates lower, and that’s why they allotted for a 1.25TN budget over a 15 month period. It is set to expire at the end of Q1 2010.

This week, their purchasing volume is down significantly. ~9BN this week. For the past few months, they had been closer to 16BN per week, and a few months earlier they were consistent at 25BN per week.

It makes sense that as they near the end of their budget, they will slow the volume. Otherwise, their departure from the market would create a demand vacuum.

Many speculate that mortgage rates will quickly return to the levels that predated the Fed buying campaign. But I don’t think it will be that severe – that environment had a number of different dimensions that do not apply today. That said, it’s helpful to note what has happened to rates this week (up) as the Fed’s buying changed (down).

It’s important to pay attention to the sociological dimensions of the financial crisis (aka Great Recession) as it continues to evolve.

I think this article on SocketSite touches on a very interesting point. Social dynamics are at play as well as financial ones on the path to a mortgage loan default and foreclosure. But as the ‘bug’ spreads, and more and more of us know people who have faced foreclosure, it becomes less of a Scarlet Letter. And that implies that the social reasons to avoid foreclosure get weaker as it becomes more prevalent around us. It’s a snowballing effect.

So before we are able to truly bottom, we need to combat this force as well as the purely economic ones.

Note – the study referenced here suggests that 1 in 3 California mortgage defaults in 2008 were strategic, which represents a 16x increase from the rate only 4 years earlier.

You’ve got to wonder about the owner who rented out this home. There are a lot of ‘accidental landlords’ out there, and maybe this is an upside-down, about to be foreclosed upon investment. But no matter what, I hope this homeowner charged a premium for rent based on tenant selection.

Here’s a great visual representation of the unemployment trend over the past few years, laid out by county for the entire US. Takes about 15 seconds to get the point across.