The Federal Reserve has a simple manual for fighting inflation. It goes like this: keep putting upward pressure on interest rates until business and consumer spending across the economy weakens and inflation recedes.
Historically speaking, the Fed’s inflation-fighting playbook always hits the US housing market particularly hard. When it comes to real estate transactions, monthly payments are paramount. And when mortgage rates spike — which happens whenever the Fed tackles inflation — those payments go up for new borrowers. This explains why, as soon as mortgage rates rose this spring, the housing market slid into a housing cooling.
But this housing correction could soon lose some steam.
Over the past week, mortgage rates have fallen rapidly. On Tuesday, the average 30-year fixed mortgage rate stood at 5.05%, down from June, when mortgage rates peaked at 6.28%. These falling mortgage rates provide immediate relief to marginalized homebuyers. If a borrower took out a $500,000 mortgage at 6.28% in June, they would pay $3,088 a month in principal and interest. At a rate of 5.05%, this payment would be only $2,699. Over the 30-year loan, this represents a savings of $140,000.
What’s going on? As economic data weakens, financial markets are pricing in a 2023 recession. This is putting downward pressure on mortgage rates.
“The bond market predicts a high probability of a recession next year, and that the slowdown will prompt the Fed to reverse course and reduce [Federal Funds] rate,” said Mark Zandi, chief economist at Moody’s Analytics. Fortune.
Although the Fed does not set mortgage rates directly, its policies do impact how financial markets value both the 10-year Treasury yield and mortgage rates. Anticipating a hike in the federal funds rate and monetary tightening, financial markets are raising both the 10-year Treasury yield and mortgage rates. In anticipation of a cut in the fed funds rate and monetary easing, financial markets are pricing in both the 10-year Treasury yield and mortgage rates. This is what we are currently seeing in the financial markets.
As mortgage rates soared earlier this year, tens of millions of Americans have lost their mortgage eligibility. However, as mortgage rates begin to fall, millions of Americans are regaining access to mortgages. This is why so many real estate professionals are pushing lower mortgage rates: they should help increase home buying activity.
While lower mortgage rates will no doubt encourage more secondary buyers to return to open houses, don’t dwell on the end of the housing correction just yet.
“Ultimately, the recent decline in mortgage rates will help at the margin, but the housing market will remain under pressure with mortgage rates at 5% (less sales, slower house price growth),” wrote Bill McBride, author of the economics study. Calculated Risk blog, in its Tuesday newsletter. The reason? Even with the one percentage point drop in mortgage rates, housing affordability remains historically low.
“If we include house price increases, payments increase by more than 50% year over year for the same house,” McBride writes.
There’s another reason housing bulls shouldn’t be overconfident: If recession fears – which are helping to push mortgage rates down – are correct, it would cause the sector to weaken further. If someone is afraid of losing their job, they will not enter the housing market.
“While lower rates by themselves are good for housing, that’s not the case when accompanied by a recession and rapidly rising unemployment,” Zandi said. Fortune.
Where will mortgage rates go from here?
Bank of America researchers think it’s possible the 10-year Treasury yield could drop from 2.7% to 2.0% over the next 12 months. This could cause mortgage rates to fall between 4% and 4.5%. (The path of mortgage rates is closely correlated with the path of the 10-year Treasury yield.)
But there is a big wild card: the Federal Reserve.
The Fed clearly wants to slow down the real estate market. The pandemic housing boom – in which house prices soared 42% and homebuilding hit a 16-year high – was one driver of soaring inflation. Falling home sales and falling home construction should ease the overstretched housing supply in the United States. We’re already seeing it: the drop in housing starts is translating into reduced demand for everything from structural lumber to cabinets to windows.
But if mortgage rates fall too quickly, a rebound in the housing market could spoil the Fed’s inflation fight. If that happens, the Fed has more than enough monetary “firepower” to put upward pressure on mortgage rates again.
“Whether we are technically in a recession or not does not change my analysis. I’m focusing on the inflation data… And so far, inflation continues to surprise us on the upside,” Neel Kashkari, chairman of the Minneapolis Federal Reserve, told CBS on Sunday. “We are committed to lower inflation. , and we’re going to do what we have to do.”
Want to stay up to date on the real estate recession? Follow me on Twitter at @NewsLambert.
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