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Will Mortgage Rates Rise in August?
Every week it seems mortgage rates inch down - but is the ride nearing the end?

One of the main reasons why mortgage rates have been so low is due to the Quantitative Easing II program. This is where the Federal Reserve Bank of New York purchases U.S. Treasury debt each business day. This massive program will end at the end of June and has kept the demand for U.S. treasuries higher than it would normally be and as a result has kept all interest rates lower than normal. So what will happen to demand for treasuries once the largest single buyer of our debt leaves the market?

U.S. banks have also been a very large purchaser of treasuries but some of Wall Street’s biggest banks are preparing to cut their use of U.S. treasuries in August as a precaution against any turbulence that could follow if warring Republicans and Democrats fail to increase the U.S. debt ceiling, a senior bank chief said.

One strategy, which bank executives only agreed to discuss without attribution due to the political sensitivities related to discussing Treasury debt, is to have more cash on hand to put up as collateral against derivatives and other transactions, decreasing the financial system’s reliance on treasuries.

“We’re planning to lower our reliance on the use of treasuries in early August and have more cash on hand as a contingency measure,” said a U.S. bank chief.

Investors worldwide own large amounts of the $9.7 trillion of debt that has been sold by the US government as part of their portfolios. But nearly 40 per cent of the existing U.S. Treasury debt – about $4 trillion – is used to back deals in the repurchase, futures and swaps markets, say JPMorgan Chase estimates.

It is this key role that treasuries play as collateral for the wider financial system where turmoil could follow any missed payment resulting from the debt ceiling fight. The top quality and liquidity of Treasury debt means it can be used to back transactions relatively cheaply, with banks or clearing houses only requiring a small “haircut” or discount on the value of the debt to reflect credit risks.

Without the Federal Reserve buying treasuries and with banks curbing their purchases as well - it could lead to higher rates.