How are Interest Rates Determined in the Market?

Interest rates on mortgages closely follow the bond market, more specifically, the 10-year Treasury bond.  Bonds move in increments of 32nds, and they move every day.  As the price, or change on these bonds go down, the yield and interest rates go up.  Bonds down, rates up.  For example, if the 10-year bond is down 16/32nds, discount points on a given interest rate will go up one-half a point (fractionally speaking, 16/32 equals one-half).  As the change on these bonds go up, the yield and interest rates come down.  Bonds up, rates down.  For example, if the 10-year bonds are up 8/32nds, discount points are likely to fall one-quarter of a point.  But what makes the bonds move?  There are many global factors that we can't foresee, however, following the economic indicators in our own economy is usually a pretty sure bet.

Here's how it works.  Each month the government releases economic indicators on the state of the economy, including many sectors; among them are housing, manufacturing, retail sales, inflation, and unemployment.  Prior to the reports being released, bond traders have already formed a consensus or forecast for the indicators about to be released, and have bought or sold bonds to position themselves for the reports.  In general, as the economy shows signs of strengthening, and a report is higher-than the forecast, bond prices will fall and interest rates will rise.  An example of this would be if the unemployment rate dropped below forecasts, and retail sales were reported stronger-than-expected, interest rates would rise.

As indicators come out weak, or lower-than forecast, bond prices will rise and interest rates will fall.  An example of this would be if factory production was forecast to rise 0.6% and it actually rose 0.2% less-than-expected, interest rates would drop.  Therefore, in general, anything that indicates a weakening economy is good for interest rates.  And anything that shows an expanding or growing economy is bad for interest rates.