The Landscape for Mortgage Rates and Inflation in 2022

This video is the latest in our Monday with Matthew series with Windermere Chief Economist Matthew Gardner. Each month, he analyzes the most up-to-date U.S. housing data to keep you well-informed about what’s going on in the real estate market.

Hello there, I’m Windermere’s Chief Economist Matthew Gardner and welcome to this month’s episode of Monday with Matthew. You know, one of the many things I love about being an economist is that it is a remarkably humbling profession. You see, just when we start to believe that our models are close to perfection, something comes along to remind us that forecasting isn’t an exact science.

And if you’re wondering what I am talking about, I recently took a look at the 2022 mortgage rate forecast I put out at the start of the year and…well, let’s say that rates rose at a far faster pace than I had anticipated. I thought that now would be a good time to take another look at rates and share my thoughts on the direction that they will likely take during the rest of the year and my reasoning behind it. And that means we need to talk about inflation.

30-Year Conventional Mortgage Rates: 2018 – 2022

So, a quick look back. As you can see, there wasn’t much to celebrate in 2018, with rates rising from 3.95% to 4.94% before pulling back and ending the year at around 4.5%. In 2019, rates fell following the Feds’ announcement that they were likely done with raising the Fed Funds Rate, and the mortgage market also reacted positively to the announcement from the White House that they were going to impose tariffs on select Chinese imported goods. We saw an uptick in late summer, but that was mainly due to news related to BREXIT.

In 2020, rates were dropping but spiked very briefly when COVID-19 shut the country down and bond markets panicked. But with the Fed jumping in with an emergency rate cut and announcing that they would start buying a significant number of treasuries and mortgage-backed securities, rates tumbled to an all-time low of just 2.66%. In 2021, rates rose as new COVID infections plummeted, but then dropped again as the Delta variant took hold, but ultimately trended modestly higher in the second half of the year.

And then we get to 2022. Rates started the year at just over 3.1% but have since skyrocketed to over 5.8% before a small pullback that started a few weeks ago. In as much as economists expected rates to rise this year, nobody anticipated how fast they would rise. So, what went wrong? Well, there’s actually a rather simple answer.

Even though we expected rates to trend higher in 2022, there were two things we hadn’t built into our forecast models.

Russia’s invasion of the Ukraine
Inflation continued to climb for far longer than we expected

So, how do things look for the rest of the year? To explain my thinking, it’s important to remember that the bond market and, by implication, mortgage rates hate nothing more than high inflation because when inflation is running hot, it limits demand for bonds which, in turn, forces the interest rate payable on bonds to rise and this pushes mortgage rates higher.

But what’s been fascinating to watch is that over the past couple of weeks, rates have actually been dropping which is certainly counterintuitive given where inflation is today. And the only reason I can see for this is that bond traders were thinking that inflation might be topping out.

But then we got the June CPI numbers, and it certainly didn’t suggest that inflation was slowing, in fact it showed the opposite. But even though the total inflation rate hasn’t yet peaked, I believe that a shift has actually started and that we are closer to a peak in inflation than you may think.

Indicators of Inflation: Consumer Spending

The June CPI report showed the headline inflation rate still trending higher but look at the core rate which excludes the volatile food & energy sectors. That has actually been pulling back for the past three months. And consumer spending when adjusted for inflation fell 0.4% in May. That’s the first monthly drop since last December, and I expect the June number when it comes out at the end of the month to show spending dropping even further.

This is a very important dataset that often gets overlooked but it is starting to tell me that the economy is slowing because of inflation and slower spending acts as a headwind to further price increases.

The core PCE price index is up 4.7% year-over-year, but this was the smallest annual increase since last November and you can see that it is also starting to roll over. This index is actually the Fed’s favored measure of inflation as it’s more comprehensive that the CPI number as it measures the change in spending for all consumers, not just urban households.

Indicators of Inflation: 5-Year Breakevens and Producer Price Index

The five-year “inflation breakeven” has plunged more than a full percentage point since peaking at just under 3.6% in late March. And this number is important as it lets us know where bond traders expect the average inflation rate to be over the next five years.

The Producer Price Index measures inflation at the wholesale, not retail, level and even though the total rate rose as energy costs continue to impact the manufacturing sector, the core rate has been pulling back for the past three months. Now let’s look at some commodity prices and see what’s going on there.

Selected Commodity Prices: Natural Gas, Copper, Soybeans, Wheat

The price for natural gas is down over 34% from its recent high
Copper prices are down 26% from the recent June peak and down substantially from March
Soybean prices are down 10%
Despite the war in Ukraine, wheat prices are down 27% from June

Retail Gas Prices: West Coast, West Coast Excluding CA, U.S.

It appears as if gas prices have also rolled over. Of course, here on the West Coast it’s more expensive than the nation even when you take California out of the equation.

U.S. Treasury Yields: 10-Year and 2-Year Constant

And finally, to cap things off, traders must also be pondering the same numbers as I am because bond yields themselves have been tumbling at both the long and short ends of the yield curve with the 10-year note still yielding less than 3% even after the CPI report and two-year yields, while still elevated, are still down from 2.42% just two weeks ago.

So, given all the charts we have looked at, I hope that you too are seeing some light at the end of the tunnel when it comes to the likelihood that inflation is about to start easing.

No doubt, the headline inflation number for June wasn’t one that anyone wanted to see but, if the trends we have looked at continue, I still expect inflation to start slowly creeping lower, which will push bond prices higher, yields will start to pause—if not drop—and that will allow mortgage rates to hold at or close to their current levels for the time being. Although we could see rates coming down, though they will still start with a five for the foreseeable future. I hope that you have found my thoughts of interest.

As always, if you have any questions or comments about this particular topic, please do reach out to me but, in the meantime, stay safe out there. I look forward to visiting with you all again next month.

Bye now.

About Matthew Gardner

As Chief Economist for Windermere Real Estate, Matthew Gardner is responsible for analyzing and interpreting economic data and its impact on the real estate market on both a local and national level. Matthew has over 30 years of professional experience both in the U.S. and U.K.

In addition to his day-to-day responsibilities, Matthew sits on the Washington State Governors Council of Economic Advisors; chairs the Board of Trustees at the Washington Center for Real Estate Research at the University of Washington; and is an Advisory Board Member at the Runstad Center for Real Estate Studies at the University of Washington where he also lectures in real estate economics.

The post The Landscape for Mortgage Rates and Inflation in 2022 appeared first on Windermere Real Estate.

The Current State of the U.S. Housing Market

Hello there, I’m Windermere’s Chief Economist Matthew Gardner, and welcome to this month’s episode of Monday with Matthew. With home prices continuing to defy gravity, mortgage rates spiking, the Fed raising interest rates significantly, a yield curve that is just keeping its nose above water, and some becoming vocal about the possibility that we are going to enter a recession sooner rather than later, it’s not at all surprising that many of you have been asking me whether the housing market is going to pull back significantly, and a few of you have asked whether we aren’t in some sort of “bubble” again.

Because this topic appears to be giving many of you heartburn, I decided that it’s a good time to reflect on where the housing market is today and give you my thoughts on the impact of rising mortgage rates on what has been an historically hot market.

The Current State of the U.S. Housing Market

Home Sale Prices

As usual, a little perspective. Between 1990 and the pre-bubble peak in 2006, home prices rose by 142%, which was a pretty impressive annual increase of 5.6% over a 16 1/2-year period. When the market crashed, prices dropped by 33%, but from the 2012 low to today, prices have risen by 131%, or at an even faster annual rate of 8.6% over a shorter period of time—10 years.

You may think that prices rising at an annual rate that exceeds the pace seen before the market crash is what has some brokers and home buyers concerned, but that really isn’t what has many people scared. It’s this.

Mortgage Rates in 2022

At the start of 2022, the average 30-year fixed mortgage rate was just a little above 3%. But, over a brief 15-week period, they have skyrocketed to 5%. This has led some to worry that the market is about to implode. Of course, nobody can say that the run-up in home prices hasn’t been phenomenal over the past few years, and it’s certainly human nature to think that “what goes up, must come down,” but is there really any reason to panic? I think not, and to explain my reasoning, let’s look back in time to periods when rates rose significantly and see how increasing mortgage rates impacted the marketplace.

Housing and Mortgage Markets During Times of Rising Rates

This table shows seven periods over the past 30 years when mortgage rates rose significantly. On average, rates trended higher for just over a year before pulling back, and the average increase was 1.4%. But now look at how it impacted home prices: it really didn’t. On average, during these periods of rising financing costs, home prices still rose by just over 5%. Clearly, not what some might have expected. But there were some negatives from mortgage rates trending higher, and these came in the form of lower sales in all but one period and new housing starts also pulled back.

So, if history is any indicator, the impact of the current jump in mortgage rates is likely to be seen in the form of lower transactions rather than lower prices. And this makes sense. Although rising financing costs puts additional pressure on housing affordability, what people don’t appear to think about is that mortgage rates actually tend to rise during periods of economic prosperity. And what does a flourishing economy bring? That’s right. Rising wages. Increasing incomes can certainly offset at least some of the impacts of rising mortgage rates.

Static Equilibrium Analysis – 1/3

To try and explain this, I’m using the median US sale price in February of this year, assuming a 20% down payment and the mortgage rate of 4%. And you can see that the monthly P&I payment would be $1,365. But as mortgage rates rise, and if buyers wanted to keep the same monthly payment, then they would have to buy a cheaper home. Using a rate of 5%, a buyer could afford a home that was 9% cheaper if they wanted to keep the payment the same as it would have been if rates were still at 4%.

But, as I mentioned earlier, an expanding economy brings higher wages, and this is being felt today more than usual, given the worker shortage that exists and businesses having to raise compensation. Average weekly wages have risen by over five-and-a-half percent over the past year—well above the pre-pandemic average of two-and-a-half percent. Although increasing incomes would not totally offset rising mortgage rates, it does have an impact.

Static Equilibrium Analysis – 2/3

To demonstrate this, let’s use the U.S. average household income of $70,611. Assuming that they’ve put aside 20% of their gross income for a down payment, they could afford a home priced just under $360,000 if mortgage rates were at 4%. As rates rise—and assuming that their income doesn’t—their buying power is reduced by over 10%, or just over $38,000.

Static Equilibrium Analysis – 3/3

But if we believe that incomes will rise, then the picture looks very different. Assuming wages rise by 6%, their buying power drops by just 5% if rates rose from 4% to 5%, or a bit less than $19,000.

Although rates have risen dramatically in a short period, because they started from an historic low, the overall impacts are not yet very significant. If history is any indicator, mortgage rates increasing are likely to have a more significant impact on sales, but a far smaller impact on prices.

But there are other factors that come into play, too. Here I’m talking about demand. The only time since 1968 that home prices have dropped on an annualized basis was in 2007 through 2009 and in 2011, and this was due to a massive increase in the supply of homes for sale. When supply exceeds demand, prices drop.

So, how is it different this time around? Well, we know that the supply glut that we saw starting to build in mid-2006 was mainly not just because households were getting mortgages that, quite frankly, they should never have gotten in the first place, but a very large share held adjustable rate mortgages which, when the fixed interest rate floated, they found themselves faced with payments that they could not afford. Many homeowners either listed their homes for sale or simply walked away.

Although it’s true that over the past two or so months more buyers have started taking ARMs as rates rose, it’s not only a far smaller share than we saw before the bubble burst, but down payments and credit quality remained far higher than we saw back then.

So, if we aren’t faced with a surge of inventory, I simply don’t see any reason why the market will see prices pull back significantly. But even if we do see listing activity increase, I still anticipate that there will be more than enough demand from would-be buyers. I say this for several reasons, the first of which is inflation.

What a lot of people aren’t talking about is the proven fact that owning real estate is a significant hedge against rising inflation. You see, most buyers have a mortgage, and a vast majority use fixed-rate financing. This is the hedge because even as consumer prices are rising, a homeowner’s monthly payments aren’t. They remain static and, more than that, their monthly payments actually become lower over time as the value of the dollar diminishes. Simply put, the value of a dollar in—let’s say 2025—will be lower than the value of a dollar today.

But this isn’t the only reason that inflation can actually stimulate the housing market. Home prices historically have grown at a faster pace than inflation.

Hedge Against Inflation

This chart looks at the annual change in total CPI going back to 1969. Now let’s overlay the annual change in median U.S. home prices over the same time period. Other than when home prices crashed with the bursting of the housing bubble, for more than fifty years home price growth has outpaced inflation. And this means we are offsetting high consumer prices because home values are increasing at an even faster rate.

But inflation has additional impacts on buyers. Now I’m talking about savings. As we all know, the interest paid on savings today is pretty abysmal. In fact, the best money market accounts I could find were offering interest rates between 0.5% and 0.7%. And given that this is significantly below the rate of inflation, it means that dollars saved continue to be worth less and less over time while inflation remains hot.

Now, rather than watching their money drop in value because of rising prices, it’s natural that households would look to put their cash to work by investing in assets where the return is above the rate of inflation—meaning that their money is no longer losing value—and where better place to put it than into a home.

Housing as a Hedge Against Inflation

So, the bottom line here is that inflation supports demand from home buyers because:

Most are borrowing at a fixed rate that will not be impacted by rising inflation
Monthly payments are fixed, and these payments going forward become lower as incomes rise, unlike renters out there who continue to see their monthly housing costs increase
With inflation at a level not seen since the early 1980s, borrowers facing 5% mortgage rates are still getting an amazing deal. In fact, by my calculations, mortgage rates would have to break above 7% to significantly slow demand, which I find highly unlikely, and
If history holds true, home price appreciation will continue to outpace inflation

Demand appears to still be robust, and supply remains anemic. Although off the all-time low inventory levels we saw in January, the number of homes for sale in March was the lowest of any March since record keeping began in the early 1980’s.

But even though I’m not worried about the impact of rates rising on the market in general, I do worry about first-time buyers. These are households who have never seen mortgage rates above 5% and they just don’t know how to deal with it! Remember that the last time the 30-year fixed averaged more than 5% for a month was back in March of 2010!

And given the fact that these young would-be home buyers have not benefited from rising home prices as existing homeowners have, as well as the fact that they are faced with soaring rents, making it harder for them to save up for a down payment on their first home, many are in a rather tight spot and it’s likely that rising rates will lower their share of the market.

So, the bottom line as far as I am concerned is that mortgage rates normalizing should not lead you to feel any sort of panic, and that current rates are highly unlikely to be the cause of a market correction.

And I will leave you with this one thought. If you agree with me that a systemic drop in home prices has to be caused by a significant increase in supply, and that buyers who are currently taking out adjustable-rate mortgages are more qualified, and therefore able to manage to refinance their homes when rates do revert at some point in the future, then what will cause listings to rise to a point that can negatively impact prices?

It’s true that a significant increase in new home development might cause this, but that is unlikely. And as far as existing owners are concerned, I worry far more about a prolonged lack of inventory. I say this for one very simple reason and that is because a vast majority off homeowners either purchased when mortgage rates were at or near their historic lows, or they refinanced their current homes when rates dropped.

And this could be the biggest problem for the market. Even if rates don’t rise at all from current levels, I question how many owners would think about selling if they were to lose the historically low mortgage rates that they have locked into. It is quite possible that for this one reason, we may experience a tight housing market for several more years.

As always, if you have any questions or comments about this particular topic, please do reach out to me but, in the meantime, stay safe out there and I look forward to visiting with you all again next month.

Bye now.

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The Impact of Rising Mortgage Rates

Hello there. I’m Windermere Real Estate’s Chief Economist Matthew Gardner. Welcome to the latest episode of Monday with Matthew.

Over the past several weeks I’ve gotten a lot of messages from you wanting me to discuss the spike in mortgage rates that followed comments by the Federal Reserve, but also asking me if there will be any impacts to the housing market following Russia’s invasion of the Ukraine. This is clearly a hot topic right now, so today we are going to take a look at how these events have impacted mortgage rates, but also look at how this may have changed my mortgage rate outlook for 2022. So, let’s get to it.

Weekly Mortgage Rates

Here is a chart that shows how rates have moved over the past two years or so using Freddie Mac’s average weekly rate for a conforming 30-year mortgage. You’ll see that rates were falling in early 2020, but when COVID-19 was announced as a pandemic they spiked, but almost immediately the Fed announced their support for the economy by implementing a broad array of actions to keep credit flowing and limit the economic damage that the pandemic would likely create. And part of that support included large purchases of U.S. government and mortgage-backed securities. With the Fed as a major buyer of mortgage securities, rates dropped ending 2020 at a level never seen in the more than 50 years that the 30-year mortgage has been with us.

In early 2021, rates started to rise again as the country became more confident that the pandemic was coming under control, but all that changed with the rise the Delta variant of COVID-19 which pushed rates lower through mid-summer. As we again started to believe that COVID was under control and a booster shot became available, you’ll see rates resumed their upward trend in August.

What has everyone worried today is this spike that really took off at the end of last year. A jump of almost a full percentage point in just eight short weeks understandably has a lot of agents, buyers, and sellers, concerned about what impacts this might have on what has been a remarkably buoyant housing market. Now, rates rising so quickly was unusual, but not unprecedented. If you really wanted to be scared, I’d regale you with stories from 1980 when mortgage rates jumped by over 3.5% in less than eight weeks.

Anyway, before we really dig into this topic, some of you may be thinking to yourselves that my numbers have to be wrong because they differ from the rates you have been looking at. This is due to the fact that the Freddie Mac survey methodology is different from other rate surveys but, even though their rates may not match the ones you’ve been seeing from other data providers, the trend is still consistent.

So, let’s chat for a bit about what caused the spike in rates. You know, it’s always good to have a villain in any story and the primary but certainly not sole culprit responsible for the jump in rates is—you guessed it—the Federal Reserve.

As I mentioned earlier, the Fed was the biggest buyer of pools of home loans (otherwise known as mortgage-backed securities) as we moved through the pandemic, but last December they announced an end to what had been an era of easy money by winding down these purchases in order to lay the groundwork for shrinking their 2.7 trillion—yes I said “trillion”—dollar stockpile of MBS paper they had built up. This decision to move from “quantitative easing” to “quantitative tightening” so rapidly had an almost immediate impact on mortgage rates simply because the market was going to lose its biggest buyer of mortgage bonds.

Immediately on the heels of their announcement, bond sellers raised the interest rate on their bond offerings to try and find buyers other than the Fed, so lenders raised the rates on mortgages housed within these bond offerings. Finally, mortgage brokers moved quickly to raise the rates that they were quoting to the public. The result of all this was that rates leapt. Although we know that the primary party responsible for rates rising was the Fed, there were other players too, and here I am talking about inflation—and as you are no doubt aware—it too started to spike at the beginning of this year and now stands at a level not seen since 1982. And if you’re wondering why inflation is important. Well, high inflation is a disincentive to bond buyers because if the rate of return, or interest on mortgage bonds, is lower than inflation, investors lose interest pretty quickly.

So, we can blame the Fed, we can blame inflation, but what about Russia? Well, their invasion of the Ukraine on February 24 has certainly influenced mortgage rates, but maybe not in the way you might expect. In general, when there’s any sort of global or national geopolitical event, investors tend to gravitate to safety, and this invariably means a shift out of equities and into bonds.

So you would be correct is thinking that at face value Russia was actually responsible for the tiny drop in rates we saw following the invasion, and also the more significant drop we saw last week when the market saw the biggest two-day drop in rates in over a decade. But before you start to think that rates are headed back to where they were a year ago, I’ve got some bad news for you. That is almost guaranteed not to happen.

Given what we know today, the terrible conflict in Eastern Europe is highly unlikely to push rates back down to where they were at the start of this year, but they will—at least for now—act as a headwind to rates continuing to head higher at the pace we have seen over recent weeks. That will continue until the conflict is hopefully peaceably concluded. And although the Ukraine situation is unlikely to have any significant impact up or down on mortgage rates, there are some indirect impacts which could negatively hit the housing market. Now I’m talking about oil.

Russia is the third largest energy producer in the world and an already tight global oil supply could get even tighter following newly announced financial sanctions on Russia. A barrel of oil has jumped by almost $20 to $109 a barrel since the start of the occupation and, if the occupation is sustained, and Russia is faced with even greater sanctions, I wouldn’t be surprised to see the price of gas rise by between 20 and 40 cents a gallon. And it’s this, in concert with already high inflation, which will directly hit consumers wallets and this itself could certainly impact mortgage borrowing. So we can blame the Fed, we can blame inflation and we can blame Russia for the jump in rates, but are the rates you are seeing today really something to lose sleep over? I actually don’t think so. At least not yet.

Even with mortgage rates where they are today, I look at them and think to myself that they are still exceptionally low by historic standards and that there really is no need for panic. But let me explain my thinking to you. To do this, we will take a look at the impact of rising mortgage rates, not as it relates to buyers’ ability to finance a home purchase, but on how it impacts their monthly payments.

Hypothetical Home Purchase

For this example, we’ll use the peak sale price for a single-family home in America, which was just over $370,000 back in June of last year. And to finance this purchase, a buyer was lucky enough to lock in the lowest mortgage rate for that month at 2.96%. Assuming that they put 20% down, and are paying the U.S. average homeowners insurance premium and average property taxes a buyer closing on that home in June of last year would have a monthly payment of $1,682.

Now, what if a buyer had bought the exact same house but in February of this year? Well, the average rate for the third week of February was 4.06%—a big jump from last June—and higher mortgage rates would have increased their payment to $1,864. What does this all mean? Well, a jump of over a full percentage point means that the monthly payment is more, but only a relatively modest $182. So, even though rates have risen by almost a full percentage point, the increase in payments was, I think you’ll agree, relatively nominal.

But what if rates had risen to 5%? Well, that would be a very different picture with payments increasing by a far more significant $348. Of course, this is a very simplistic way of looking at it as I have not included any other debt payments that a buyer may have, but I hope that it does demonstrate that, even though mortgage rates are certainly significantly higher than they were last summer, because we started from such a low basis, monthly payments have seen a relatively modest increase. The bottom line is that rates were never going to hold at the record lows we have seen, and we need to just accept the fact that they will continue trending higher as we move through the year but are yet at a level that suggests impending doom for the housing arena. So, where do I think that rates will be by the end of this year? Well, here is my very latest forecast for the rest of this year.

Mortgage Rates Forecast

Given all we know in respect to the Fed and the current situation in Ukraine, my model suggests a significant jump in the first quarter, but then the pace of increase slows significantly and we will end this year at a rate that is almost half a percentage point above the forecast I offered at the start of the year.

Forecasts From Various Analysts

Of course, this is the opinion of just one economist, so I thought it would be useful for you to see what others are thinking. And amazingly enough, most of us—at least for now—are still in a pretty tight range regarding our expectations for the average rate in the 4^th quarter of 2022 with Fannie Mae at the low end of the spectrum and the Mortgage Bankers Association at the high end.

I honestly believe that, all things being equal, the impact of higher mortgage rates is unlikely to significantly impact the U.S. market this year and, even with rates rising, the market will remain tight in terms of supply and will continue to favor home sellers. That said, once we break above 4.5%, I would expect to see the increased cost of financing having a greater impact on not just on demand but on price growth, too.

And if you are wondering why I am so sure about this, it’s simply because we saw the exact same situation in 2018 when rates rose to 4.9% and we saw a palpable pull back in sales; which dropped from an annual rate of 5.4 million to 5 million units and the pace of price growth dropped from 5.9% to 3.3%. Now, I don’t see rates getting close to 5% for quite some time and therefore still expect demand to remain robust—off the all-time highs we have seen—but still solid given demographically-driven demand as well as increasing demand from buyers trying to find a new home before rates much further.

Of course, the impact of rates rising will not be felt equally across all markets. Many areas, and especially in coastal States, have seen home values skyrocket to levels that are well above the national average. Although incomes are generally higher in these markets, buyers in more expensive areas will feel more pain from higher financing costs.

And there you have it. I hope that today’s chat has not only given you some additional tools to use in your day-to-day business but has also given you enough information to hopefully ease some of the worry that many of you are feeling right now. As always, if you have any questions or comments about this particular topic, please do reach out to me but, in the meantime, stay safe out there and I look forward to visiting with you all again next month.

Bye now.

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10/25/2021 Housing and Economic Update from Matthew Gardner

Hello there! I’m Windermere Real Estate’s Chief Economist, Matthew Gardner, and welcome to the latest episode of Mondays with Matthew.

A few weeks ago, one of my viewers on You Tube sent me a note asking when I was expecting mortgage rates to start to rise and, if I believed that they were going to go up, how fast will they rise, and what impacts will higher rates have on home prices.

Well, I would like to thank this particular viewer for the question, and it’s going to be the topic of today’s video.

How Mortgage Rates Are Set

But before we start looking at the future of mortgage rates, I was speaking to some of our interns here at the office a while ago and one of them asked me to explain how mortgage rates are set and – because this is somewhat pertinent to today’s topic – I thought that I’d take just a minute or two to explain to you how this all works.

Of course, there are a lot of factors that impact the rate that a home buyer themselves will get, and they include credit quality, loan-to-value ratios and the like, but the base rate is set not by looking at a home buyer, but at the economy itself and, specifically, the bond market – and even more specifically, the interest rate of 10-year US treasuries.

Now, if you’re asking yourself why 30-year mortgages are based off 10-year bonds and not 30-year? Well, that would be a good question, and this is the answer. You see we move, on average, every 10 years and that’s why!

Here is a chart showing the average yield – or interest rate – on 10-year treasury bills by month going back to 2010 in light blue, and the average 30-year mortgage rate in dark blue. I hope that you can see the tight relationship they have to each other.

Of course, there are times when bond yields can go down and mortgage rates rise, and vice-versa but, in general, they track each other pretty closely.

And if you’re wondering why the rates aren’t simply the same, well it’s because a treasury bond has no risk – as its backed by the US government – but there is some risk associated with a mortgage, so buyers of mortgage bonds expect a premium to be added because of this risk, and this has averaged just over 1.5% since the 30-year mortgage came into being back in the early ‘70’s.

Now, there are some people out there who think that the interest rate on 10-year treasuries doesn’t set mortgage rates, rather its better to track the interest paid on mortgage bonds and, although I do see why they might think this, the base mortgage rate is actually set by treasury yields and the interest on mortgage bonds is set using that base and adjusting it to manage the prevailing risk tolerance that investors are prepared to accept so I believe that watching movements in the interest paid on 10-year treasuries is the right way to go.

And that, in essence, is how the 30-year mortgage rate is set.

The History of Mortgage Rates

If you are a regular viewer of these videos you will now that I like to start off with some context to the subject I am addressing and this chart will show the average rate for conforming 30-year fixed rate mortgages going back to their genesis in the early 1970’s.

Back in ‘71 rates were in the mid-7% range, rising to just under 10% in ‘74, before pulling back but, as you can clearly see, they started to spiral upward in ’77, ending the decade at almost 13% and if you’re wondering what led to this massive jump, well this was because the country had entered a period of high inflation.

In the ‘70s the country was pushed into a recession basically due to an oil embargo that led to the price of oil quadrupling and that led to a period of so-called stagflation which is when inflation rises, and economic activity slows.

And in the early ‘80’s we entered a period of so-called hyperinflation, as another oil embargo was took hold and the Fed was forced to step in and raised short-term rates which led rates along the yield curve to rise and this – of course – included 10-year treasuries which hit 15.3% in the fall of 1981 and that, as we have discussed, caused mortgage rates to hit an all-time high in October of 1981 at close to 18.5%. Rates then started to pull back and

In the 90’s, rates started to trend lower but jumped again in ’94 as the Fed tightened monetary policy given the significant growth that the country was seeing, but they started to pull back in the second half of the decade, falling to the mid-6’s before notching higher in ’99.

In the 2000’s, rates dropped to 5.3% in 2003 as the housing market boomed but, as we all know, it wasn’t all unicorns & rainbows in this decade of what was then – historically low rates.

The housing crash led the Fed to jump in by cutting interest rates, but they also started a massive purchase of mortgage bonds at very low interest rates as they were happy to take a low return as long as it stabilized the housing market. As a result of their efforts, mortgage rates fell almost a full percentage point, averaging just a hair above 5 % in 2009.

Riding the wave of low bank borrowing costs, mortgage rates entered the new decade around 4.7% and continued to fall steadily, dropping to the mid-3’s by 2012. But in 2013 you can see that rates headed higher. Why? Well, a big part of this has to do with some panic in the bond market, but we will get to that shortly.

Anyway, rates went up in 2014 before dropping to 3.85% in 2015 as the market calmed down.

They rose again after the 2016 presidential election, reaching their peak at the end of 2018 and start of 2019, but still ending the decade below 4%.

As for the current decade, well, it’s all been about COVID-19.

To understand what’s happened over the past couple of years, we need to look at the weekly average rate and I am sure that you have noticed the first spike in the graph.

And it was totally due to the Coronavirus which created an unprecedented situation for all rates (not just mortgages, but US Treasuries and everything else).

You see, investors were panicking during the early stages of the pandemic, not just because the country – essentially – shut down for a brief period, but there were rumors about a thing called forbearance, and investors were panicking that they would not get paid for the mortgage bonds they held, and they did what we all do when we get worried about the economy and, specifically, our investments. They get out of their investment positions and into cash and that’s absolutely what they did, but I should add that I am not talking about them stashing dollars under the mattress. No, they moved into cash positions in financial markets, which are the most liquid, nimble place an investor in the US can be.

And with a lot of institutions and individuals getting out of bonds and not many buyers out there, what happened to rates? That’s right, they rose to attract buyers and rise they did. So much so, in fact, that on a single day in March of 2020, mortgage bonds prices changed 5 times! Quite unprecedented.

Anyway, the Fed reverted to their old playbook and went on a massive bond buying spree with the biggest ever purchase of mortgage-backed securities on Thursday March 19 but, quite remarkably, they announced the very next day that they were going to buy even more. How much more, you ask… Well, they decided to buy three times more than the record purchase they made just the day before!

And because of this, rates dropped dramatically and continued to pretty much head lower for the rest of the year and into early 2021.

But then the music stopped, as you can see in the second highlighted spike in the above graph.

You see, a special election was being held in Georgia and the bond market decided to take a conservative stance prior to the election and that led rates higher again. But the election wasn’t the only reason why rates rose.

You see, COVID 19 cases that were dropping, improved vaccine distribution appeared to be in place, there were several stronger than expected economic reports released, and progress on a fiscal stimulus package. All of these factors led rates higher because, as you know, when economic news is positive, that is actually bad for bond yields as people move back into equities and out of bonds which is obviously bad for mortgage rates as bonds need to offer a higher interest rate to attract the few buyers that were out there.

Mortgage Rate Forecast

So that’s where we are today, but what of the future?

Here is my forecast for 10-Year treasuries through the end of next year and you will see that I am looking for rates to rise gradually as we move into next year and this will lead mortgage rates to start notching higher as well.

And here is my forecast for mortgage rates. Although they should move higher, I am still not seeing rates break above 4% until 2023 at the earliest and – even as they start to increase – I really don’t see it as a major deterrent to home buyers.

But before you start to say that this is only one person’s forecast and it could be wrong, lets look at my forecast compared to some of my industry colleagues.

As you can see, we are all in a pretty tight range when it comes to forecasting the average rate this year and next.

The bottom line is that although rates will rise, they will remain very competitive when compared to historic averages and the upward trend in rates is unlikely to have any significant impact on prices. That said, many markets are already having an affordability crisis and rising rates will certainly act as an additional headwind to price growth; however, it would take a significantly greater increase in rates to negatively impact prices.

Well, I hope that you have found this month’s discussion to be interesting. As always if you have any questions or comments about this topic, please do reach out to me but, in the meantime, stay safe out there and I look forward the visiting with you all again, next month.

Bye now!

The post 10/25/2021 Housing and Economic Update from Matthew Gardner appeared first on Windermere Real Estate.