Shift In Chinese Foreign Investments Could Adversely Impact U.S. Mortgage Rates

According to the San Jose Mercury-News, the U.S. real estate market could be influenced adversely in 2006 by a factor few buyers or sellers even consider — China.

The world’s most populous nation recently signaled that it may diversify foreign investments in 2006, leaaving mortgage industry watchers concerned. If China buys fewer U.S. Treasury securities this year, interest rates may surge higher and pour more cold water on a real estate market that already looks to be cooling off somewhat.

China’s foreign currency regulator said its plans for 2006 include actively exploring more efficient use of our [foreign-exchange] reserve assets and widening the reserves investment scope. While China’s central bank said last week that it has no plans to sell dollars from its $800 billion-plus foreign reserves, some analysts predict China may buy less U.S. government debt at Treasury auctions this year.

Like Japan, China is a large buyer of U.S. Treasuries and other U.S. debt such as securities issued by housing agencies Freddie Mac and Fannie Mae. China sees the U.S. debt market as stable and liquid — as opposed to other countries’ debt — and its vast purchases have helped keep U.S. interest rates relatively low in recent years. Ken Hackel, chief fixed income analyst at RBS Greenwich Capital Markets, believes there could be fewer purchases of 5- and 10-year U.S. government notes at regular U.S. Treasury auctions.

So how does this affect the mortgage rate you receive?

Well, U.S. mortgage rates are closely tied to Treasury rates and any rise in the cost of borrowing could slow home sales. A series of increases in the overnight bank lending rate by the Federal Reserve since 2004 has already made adjustable-rate mortgages more pricey, while additional increases in 10-year Treasury notes, used by lenders as a benchmark for 15- and 30-year fixed-rate mortgages, could add to the cost.

“If it comes to pass that long-term Treasury yields are higher, that means that mortgage rates will become more expensive for consumers,” said Frank Nothaft, chief economist at Freddie Mac.

While China has signaled a shift in its buying patterns, it likely won’t completely abandon U.S. dollar-denominated assets like debt issued by Fannie Mae and Freddie Mac. China’s central bankers have a choice of investing the U.S. currency in dollar-denominated assets like U.S. Treasury bonds or trading it for other currencies.

“If they diversify from the U.S. dollar denominated assets, it would lower the value of the U.S. dollar relative to China’s currency, the yuan, and make it more expensive for American companies to buy goods made in China,” said Chris Low, chief economist at FTN Financial.

Nothaft and Hackel also do not expect China to let its currency rise in value by selling U.S. dollars, and point out that any drop in demand from China could be made up for by investors like U.S. brokerage firms or foreign investors, containing a rise in U.S. interest rates.

When this trickle-down effect would start being noticed is unclear, as is the extent to which it will push rates upward. Currently, fixed-rate Florida home loans are averaging 6.15 percent, having dropped for the second consecutive week. It’s unlikely that any action by China or the U.S. will push rates over 7 percent this year, but the current figure is quite low. Take a look at your finances and what you can afford, then take advantage!