Cyprus Reaches Bailout Deal

It was a relatively quiet last week. Mixed US economic data had little impact. Events in Europe were the main influence on mortgage rates. Investors grew more concerned that uncertainty in Europe could slow the pace of global economic growth.

The bank problems in Cyprus raised broad questions about the relationship between the troubled countries and the stronger countries in the European Union (EU). Early in the week, Cyprus reached an agreement to receive an EU bailout package for its banks. The terms of the aid highlighted the growing reluctance of Germany and the other healthier countries to use taxpayer funds to provide aid to the weaker countries. Investors are concerned that this may slow the implementation of unpopular reform measures intended to boost economic growth in the troubled countries. Adding to the uncertainty, Italian leaders have made little progress in forming a coalition government, making it very difficult for the third largest country in the EU to do anything to improve its economic situation.

So why is political and economic uncertainty in Europe positive for US mortgage rates? Since US companies conduct business in Europe and export to Europe, slower growth there will be a drag on the US economy as well. This results in reduced expectations for future inflation, which is good for mortgage rates. In addition, the duration of the Fed's MBS and Treasury purchase program depends on the strength of the US economy and the labor market. Weaker growth and lower inflation could justify Fed purchases for a longer period of time, providing an extra benefit for mortgage rates.