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After falling to historic lows of less than 5%, then suddenly spiking dramatically higher to almost 6%, mortgage rates have drifted down by about 1/2 percent. Here in the Chicagoland area they have been stuck in a range roughly between 5.125% and 5.625%, of course depend on factors like the borrower's FICO score and the Loan to Value ratio of the deal. The market forces that determine what interest rates will be are engaged in a tug of war or sorts, with the result so far being a standstill.

We have the following market forces that are pushing rates higher:

1) The US Dollar falling in value against other major currencies.

Since Bonds are denominated in US Dollars, the true yield must be adjusted lower since the investors Bonds will be worth less if the Dollar is worth less than when they made their purchase. Therefore investors demand a higher rate of return on their bond purchases.

2) Anticipation of an increase in the rate of Inflation.

A higher rate of inflation makes the Dollar worth less, so as in the example above, a Bond investor will demand a higher rate of return to compensate for this lower real return due to inflation. We should note that at this point, we are only talking about anticipation or expectations due to the increase in the money supply. The actual inflation rate is quite low. According to the Bureau of Labor Statistics the CPI increased at a seasonally adjusted rate of 0.1 percent in May, at 0.0 percent or unchanged in April, and the index has fallen 1.3 percent over the last 12 months.

The economy is not nearly strong enough to create demand-pull inflation, and with high unemployment I cannot see the basis for cost-push inflation either. I think that the inflation fear mongers can be ignored for now. Given the Trilions of dollars of wealth that were destroyed in the crash of October 2008, much of an increase in the money supply will simply be sopped up in a system where banks must now deleverage to strengthen their balance sheets.

We have the following market forces that are pushing rates lower:

1) Strong demand for Bonds.

When the stock market crashed, many investors tok what they had left and put it in safe havens like Bonds. The Fed's strategic purchases of Treasuries has also kept demand strong, albeit at somewhat higher yields.

2) A Shrinking TED Spread.

The TED Spread is a commonly accepted measure of investors appetite for risk. A higher spread means investors demand higher rates to compensate for this perceived higher risk. A lower spread means investors are clam enough to accept a lower rate of return. The spread hit a high of 463 in October 2008. It is now at 42.

I like Investopedia's explanation of the TED Spread so much I'll quote them here - "The Ted spread can be used as an indicator of credit risk. This is because U.S. T-bills are considered risk free while the rate associated with the Eurodollar futures is thought to reflect the credit ratings of corporate borrowers. As the Ted spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the default risk is considered to be decreasing."*

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