In today’s globally interconnected economy, nothing happens in a vacuum. Each piece of the economic puzzle ties in with the rest of the world’s economy, sometimes in surprising ways.
Mortgage interest rates are set by lenders, based on lenders’ understanding of current and future economic conditions.
But pinning down the ‘right’ interest rate isn’t easy. Economic conditions can change quickly. Lenders make constant adjustments based on new information, which is why mortgage interest rates fluctuate. (It’s also why rate locks on mortgages are so important.)
Sometimes, seemingly unrelated economic conditions can affect the price of borrowing for your home.
For example, you might not think bacon has anything to do with banking, mortgages, or interest rates. And most of the time, you’d be right. There are lots of other economic indicators that are more important in determining the cost of your mortgage.
But bacon and mortgages aren’t entirely unrelated. Seriously.
Stocks and Bonds Aren’t the Only Games in Town
Most folks have heard of the stock market. In the stock market, investors buy shares in companies, hoping that the companies they invest in will do well and make profits.
In the bond market, investors buy bonds. Bonds represent a portion of a debt to be paid back at some later date, with interest. With US Treasury bonds, for example, an investor loans their money to the US Federal Government. There are lots of other types of bonds, too.
But the stocks and bonds aren’t the only places investors can put their money.
In the commodities markets, investors make bets on the future production of raw goods. There are commodities markets for precious metals like gold and copper; energy products like coal and oil; and agricultural products, like wheat, corn, and certain kinds of livestock.
(Years ago, a person could get into the commodities market at Chicago Mercantile Exchange and trade specifically in pork bellies, the part of the hog used to make bacon. Chicago Mercantile Exchange stopped trading pork bellies in 2011, but today investors can still trade in lean hogs.)
Investing in Bacon
Here’s how commodities trading works: investors in commodities buy and sell contracts called ‘futures’. Basically, an investor agrees to a price at which he will buy or sell a certain quantity of hogs or gold or corn on a given date in the future. So, for example, you could agree to purchase 40,000 pounds-worth of hogs at $75 per 100-pounds, six months from now. In six months, if hogs are being sold for $80 per 100-pounds, you’d make some money on your investment.
On one level, commodities investments are reliable. People heat their homes and drive their cars and eat bacon year in, year out. But commodities are vulnerable to a variety of uncontrollable and essentially unpredictable risks. A drought can totally wipe out wheat yields. A swine flu could decimate the hog population.
How Does Commodities Trading Influence Mortgages?
For most everyday investors, commodities trading only becomes really attractive when the stock market stops looking like a good place to put their money.
Which means that when demand for investment in commodities goes up, mortgage banks and lenders notice. The price for hogs and other commodities go up for a number of reasons, of course.
But let’s say the price of bacon starts heading upward because more people are trying to invest in lean hogs. Mortgage lenders will notice that. Increased interest in commodities trading historically precedes shaky stock markets and periods of inflation.
And inflation is bad for lenders. It means the money they loan out will be worth less in terms of real buying power by the time the borrower pays the money back. When lenders think the rate of inflation is likely to head upwards, they’ll usually adjust their mortgage interest rate upwards, too.
It may sound crazy, but the price of pigs probably is somewhere in your lender’s list of things to factor into calculations about the risk of lending you money to buy a home.
One more thing to think about the next time you eat a BLT.