The Connection Between Oil Prices and Mortgage Rates

You’re surely been following the news and hearing or reading about the price of oil lately. If you haven’t, well, we’re at levels we haven’t seen in decades. Low levels. Currently, the price for a barrel of oil hovers around $30 with some even predicting prices to fall a bit more over time. Quickly compare this price with the record peak of just under $150 per barrel back in 2008. That’s quite a drop. And it happened relatively quickly. What’s causing this reduction? There are of course several factors involved and there’s really no need to get into all of them, but recent geopolitical factors look to have played the most important part.

The United States is now a net energy producer. We find and export more oil and gas products than we ever have before and as such are no longer dependent upon foreign sources of oil. Low energy prices help both business and the private sector. Gas prices at the pump are lower. Factories spend less on production costs than they used to and products derived from petroleum are also less expensive to manufacture.

At the same time, rates for mortgages have also dropped. Mortgage rates recently approached lows not seen in five decades, this according to Freddie Mac’s most recent weekly mortgage rate survey. I’ll say that again, that’s 1970. Richard Nixon was president. We have to go back that far to compare rates where they are now compared to then. Okay, so we’ve got two completely different products, oil and mortgage rates. Are they connected?

Here’s my theory. I think it’s more than a coincidence, albeit a fortunate one for consumers. Think about that for a moment. Oil prices near record lows and rates matching lows not seen for five decades. What’s interesting about the price of oil at this stage is how these prices are being driven. Historically, if the price of oil drifts lower, oil producing countries pull back on production to push the prices back up. These producers from different countries get together and talk about the price of oil and whether or not to increase, decrease or keep production the same. Today however, it’s more of a political situation abroad. Instead of pulling back on production to prop up prices, countries are pumping out more oil to make up for the loss. This is backwards from the traditional approach.

So, what about those rates? Economic and political instability can cause investors to get more than a bit nervous. We recently wrote how investors will pull out of equity markets and into the safety net of bonds, including mortgage bonds. The result of greater demand for a bond means sellers can command a higher price for a bond. Higher bond prices mean lower rates, that’s how bonds work.

I believe investors overall are uncertain how this will ultimately play out. It’s really uncharted territory. When our economy is running on all cylinders, economists will tell us commodities in general will increase in price due to demand, oil included. Following that theory, we should be experiencing higher rates, not lower ones. However, the difference is the uncertainty this time around. The political moves abroad are nearly unprecedented. For economies whose main producer of revenue is oil, what will become of them? How long can their economies last when they’re selling oil at such a low price the revenue produced isn’t enough to sustain a recovery. It very well might, but no one knows. This is a new thing. And when investors don’t see a clear path to prosperity, they’ll pull back from stocks and back into bonds.

Rates and outlooks can change on a dime. Many times, it’s due to things beyond our control. Forecasting what might happen in the near future is dicey but for now, you really can’t beat these mortgage rates.