This is a pretty simple concept to understand. Oil is and has been a hedge against inflation for a very long time. This is because oil is traded in US currency making it an attractive investment to investors trading in foreign currency when the value of the dollar is on the decline. They buy and hold on to the oil futures until the dollar recovers a bit leading to a sell off and profit taking.

Since oil is currently such an attractive investment to investors trading in foreign currency we are seeing huge oil rallies that are driving the price per barrel perpetually upward. Of course this is causing a trickle affect in the sense that the majority of our goods are delivered by plane, train, and truck all of which use derivatives of oil as their fuel sources.

Another factor to consider is that many goods are made by equipment that uses diesel fuels and other derivatives of oil as well. Many of our goods are being produced and delivered through the use of fuels that are derived from oil. Considering that Oil is at slightly less than $136.00 per barrel right now it stand to reason that the cost of our goods and services cost more.

But How Does This Affect Interest Rates?

You might ask... Well, again this is pretty simple. Interest rates on fixed rate mortgages move in lock step with the 10 year treasury bond; the higher the yield the higher the interest rates. Their are some pretty complex calculations that go into the determination of interest rates for for the purposes of this post I am going to K.I.S.S... Thats right I am going to Keep It Simple.

The yield on the 10 Year Treasury Bond moves opposite its price. The higher the price the lower the yield and vise versa. That is in large part due to the fact that if you pay more you net less... See pretty simple so far.

Here's where things get a little bit complicated -> Bonds are extremely sensitive to inflation... Again there are some complex calculations that go into the reasons for but for the purposes of K.I.S.S I will say simple that inflation could turn your investment in the bond market south real quick. In large part that is due to the fact that the dollars that you just invested into the bond market are now worth less.

I am not going to stray too far into the algorithms that make up the bond market except to say that inflation makes the bond market an unwise investment. Accordingly since bonds are often packaged into mortgage backed securities when the bond market is under diress mortgage interest rates go up.

In order for the bond market to start doing well we are going to have to see a reduction in inflation. The only real way to boost the value of our dollar is for the FED to raise the FED Funds rate. That of course will lead to a sell off of oil which will lead to a lower cost per barrel, lower inflation, and ultimately lower mortgage interest rates.