One of the factors for this is swap rates, so Mortgage Solutions has engaged the experts to find out exactly what they are, how they work, why they’ve been rising, and what brokers can do to help their clients.
What are swap rates?
Swap rates are when two parties swap interest rate payments for another. One party agrees to receive a fixed-rate payment, while the other receives a variable payment.
In the case of mortgages, it is what lenders pay to financial institutions to acquire fixed funding for a set period of time. They can be on a number of terms, including one, two, three, five and 10-year terms, and the cost is used to price mortgage product for lenders.
As swap rates are based on what the markets think interest rates will be, if they rise then mortgage lenders will increase their pricing to maintain their profit margin, or if they rise too rapidly then they may have to pause lending or withdraw products until pricing stabilises.
What has been happening?
Alex Maddox, head of capital markets at Kensington Mortgages, said that historically one or two basis point changes per day in swap rates would be normal but over the past few months they have been “persistently volatile”,
He continued that swap rates had now been regularly changing by five to 10 basis points for an “extended period” as the Bank of England has been increasing the base rate.
Mark Harris, chief executive of SPF Private Clients, said that this volatility reached a new peak in the last week of September, with two-year swaps jumping by 100 basis points in one working day.
He said that this made it “difficult for those utilising the money markets to know where to buy”, leading to some lenders pulling products.
Jeremy Duncombe, managing director of Accord Mortgages, agreed, saying that swap rates were now “moving more often and by bigger amounts”.
“For context, a year ago we’d be looking at two-year swaps of circa 0.50 per cent. This increased over the following nine months to reach more than three per cent in the summer but had almost doubled again weeks later to the end of September.”
Why have swap rates become more volatile?
There are several factors as to why swap rates have been especially volatile over the past few months, including base rate increases, the war in Ukraine, rising inflation and the fall in the value of sterling.
Duncombe said: “The uncertainty surrounding the rising cost of living, inflation and ongoing conflict in Ukraine all continue to influence swaps and was recently compounded by the fall in the value of sterling.”
Following Chancellor Kwasi Kwarteng’s announcement of the mini Budget, the pound fell to a record low as various tax-cutting measures were expected to be financed by debt. This unnerved investors and caused a pound sell-off. The pound has since recovered slightly.
Amid economic uncertainty after the mini Budget, it also looked likely that the Bank of England would increase base rates again to try and stabilise the economy.
Maddox added: “The volatility has been driven by capital markets trying to come to terms with the pull and push of recession and high inflation. There are days where recession seems to be more likely driving swap rates down, and then when inflation became the main concern, swap rates went up.”
He said that after an extended period of volatility, markets were “not particularly deep” and there wasn’t a lot of liquidity, so news would “cause a disproportionate market move”.
“I think what you had was a lot of news coming out at the same time, and some relating to confidence in the government and central bank, so I think that probably overly worried the market and caused more of a market reaction than perhaps it would have done if we hadn’t been in such a long period of volatility,” Maddox continued.
He noted that there were also “second-order effects” where some debt funds liquidated positions to raise cash and the central bank stepped in, which caused rates to “come down quite significantly”.
Why did this have such an impact on the mortgage market?
Maddox said that a key challenge was that retail markets were not set up to move as quickly as the capital markets.
“A trader can change their market price in milliseconds but changing a rate on a mortgage system for some lenders can take quite a while,” he noted.
Maddox also said that even after pricing, feeding those changes through “other bits of plumbing” such as sourcing systems also added time.
“There’s just a very different timescale used in the retail markets compared to the capital markets and in the past, that didn’t matter so much. But I think what I would expect out of this, longer term, is that lenders, sourcing systems and the industry as a whole will look at ways in which they can at least make product pricing a little bit more fluid and, therefore, be able to keep products in the market rather than having to pull them,” he explained.
Maddox said that the recent turbulence was a “very extreme event”, so it didn’t make sense for the mortgage market to build infrastructure for this scenario, but digital platforms could help move rates more quickly.
Will this volatility continue?
Duncombe said that it was “highly likely” that there would be continued swap rate volatility in the immediate term as there were “many influencing factors that we can’t control”.
As swap rates are based on assumptions of what interest rates will be, if they are expected to rise then swap rate changes would continue.
Harris explained: “Market anticipation is that the base rate will have to move faster, higher and for longer.”
“The Bank of England is expected to further increase the base rate again in November when it next meets. The range of increase is open to debate but anywhere between 0.75 and 1.25 per cent is entirely feasible.”
He noted that had there not been recent interventions and changes to government policy and announcements, there was a chance that the base rate could have been higher.
Harris said that recent base rate forecasts expect the base rate to peak next year at around 5.5 per cent.
What can brokers do?
Duncombe said that there was a “lot of misunderstanding around mortgage pricing”, so brokers who better understand the make-up of mortgage rates would be better placed to advise clients in the current environment.
“Being able to confidently talk about what is happening and why can demonstrate awareness, understanding and empathy to borrowers at what is an unsettling time for many. Proactive contact with customers in times of uncertainty will always position the broker at the centre of the conversation,” he added.
Harris said it was important for advisers to engage their clients and assess options given expectations, current situation, future events and motivations.
“Anyone coming off a fixed rate any time soon is likely to experience a payment increase although some of the horror stories seen in the media are few and far between. Advisers can run through the various product options and assist with budgetary requirements while outlining the pros and cons,” he added.
“Any borrower concerned about entering financial/payment difficulties should engage with their lender and adviser straight away.”
Maddox continued: “For brokers, it’s very difficult for them to advise clients what to do. But I think that there’ll be more and more customers out there wanting advice on interest rates and brokers are well placed to explain the different options and the pros and cons.”
He said that this could increase discussions around long-term fixed rates and floating rate mortgages.