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Housing demand remains above long-term averages, but a shortage of inventory means sales won’t resume until mortgage rates approach 5 percent, Fitch Ratings analysts said Thursday.
And because many mortgage-funding investors were already pricing in Wednesday’s Fed rate cut, they may have to talk less about the risks involved in mortgage financing if mortgage rates fall more than they already have, Fitch analysts warned.
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“Housing demand, as measured by homes sold above list price and average resale price, has softened since August 2023 but remains above the long-term average,” Fitch analysts said. “Further reductions in mortgage rates will help improve affordability and support demand, but the low structure may slow home sales until rates approach 5 percent.”
For those keeping a close eye on mortgage rates, the Fed’s much-anticipated rate cut this week may seem ominous.
After the central bank lowered short-term interest rates for the first time in 4 years – kicking off what is expected to be a long-term rate-cutting campaign with a dramatic 50-basis-point cut – FHA and mortgage rates actually rose. less on Wednesday.
One of the reasons that mortgage rates are rising is that Fed policymakers have been telegraphing their intention to cut rates for months. Since hitting a 2024 peak in April, prices for the 30-year fixed-rate mortgage have already fallen by more than a percentage point this summer.
The Fed’s monetary policy tools allow it to make precise changes in short-term interest rates, keeping the federal funds rate within a quarter point of half a point desired by policymakers.
But the central bank has no direct control over long-term interest rates such as Treasury yields and mortgages, which are largely determined by supply and demand. If investors – who weigh factors including inflation expectations, economic growth and monetary policy – decide it would be wise to buy government bonds and mortgage-backed securities, that could lower long-term interest rates.
When Fed Chairman Jerome Powell was asked on Wednesday how much he thought mortgage rates might fall in the next year, he suggested he was the wrong person to ask.
Powell’s press conference
“It’s very hard for me to say,” Powell told Elizabeth Schulze of ABC News. “From our point of view, I can’t really talk about housing costs. I will say … that will depend on how the economy develops.”
Powell pointed Schulze to the Fed’s latest Summary of Economic Projections (SEP), which shows what members of the Federal Reserve Board and Federal Reserve Bank presidents expect to happen to growth, unemployment and inflation in the coming months and years. – and how they think in the short term. interest rates may need to be adjusted.
To combat inflation during the crisis, Fed policymakers raised the federal funds rate 11 times between March 2022 and July 2023, bringing it to a target between 5.25 percent and 5.5 percent – the highest rate since 2001. percentage.
The “SEP” – and the “dotted structure” associated with it – show that the average expectation of Fed policymakers is that by the end of next year, the federal funds rate will be 2 percent lower than before Wednesday’s rate cut.
“If things go according to that forecast, other rates in the economy will also go down,” Powell said. “But the extent to which those things happen will depend on how the economy is doing. We cannot look a year ahead and know what the economy is going to do.”
The Fed lowered the price to house prices
Lock-in rate data tracked by Optimal Blue showed that rates for a 30-year mortgage due 2024 were 6.03 percent lower on Tuesday, but rebounded 5 basis points after Wednesday’s Fed meeting.
The Mortgage Bankers Association’s weekly survey of lenders showed that home loan applications rose a seasonally adjusted 5 percent last week compared to the previous week, but were slightly lower (0.4 percent) than a year ago. Applications for refinancing were up 24 percent each week and 127 percent from last year.
Demand for mortgages that meet the needs of Fannie Mae and Freddie Mac has increased since last year, as buyers see improved affordability conditions, driven by lower rates and slower home price growth, said MBA Chief Economist Joel Kan, in a statement.
Conforming mortgage rates have already fallen more than the full amount from the 2024 high of 7.27 percent registered on April 25 – about where economists at Fannie Mae and the Mortgage Bankers Association (MBA) forecast in August will be at the end of next year.
Loan rate forecast
Source: Fannie Mae and Mortgage Bankers Association forecasts, August 2024.
Taking an even longer view, Fitch Ratings analysts said Thursday they expect the 10-year Treasury yield, a barometer of borrowing costs, to still be at 3.5 percent by the end of 2026 — just a quarter of a point lower than Thursday’s close of 3.74 percent. .
For mortgage rates to drop significantly, the “spread” between 10-year Treasury and 30-year mortgage rates would have to narrow, Fitch analysts said.
The 30-10 spread — calculated by Fitch at 1.8 percent during the decade before the pandemic — grew by 3 percent at times last year.
The Fed is reducing its mortgage rates
Investors have been seeking higher returns on mortgage-backed securities (MBS) because of “prepayment risk” – the fear that borrowers who take out loans when mortgage rates are raised will re-pay them when they fall.
In addition to prepayment risk, demand for MBS has decreased as the Fed reduces large amounts of MBS and government debt — a process known as “quantitative tightening.”
As mortgage rates decrease, so does prepayment risk. Fitch analysts think mortgage rates say the 30-10 spread has already narrowed to 2.6 percent this year, but that trend will need to continue to help get loan rates below 6 percent.
If the 10-year Treasury yield falls to 3.5 percent and the 30-10 spread returns to 1.8 percent, that would translate to a 5.2 percent mortgage rate, Fitch analysts said.
When they released their latest economic and housing forecasts in August, economists at Fannie Mae said it would take time for lower rates to translate into sales.
Part of the problem is that in addition to making homes more affordable for buyers, higher mortgage rates have created a “lock-in effect” for would-be sellers who are reluctant to offer lower rates on existing mortgages.
Asked whether lower mortgage rates might revive demand for housing and boost prices, Powell said lower rates should also help produce more, by reducing the foreclosure effect and bringing more inventory to the market.
“The housing market is partially frozen because of the lock in low prices,” Powell said. “People don’t want to sell their houses because they have very low income [rate and] it can be very expensive to get a refund. As prices come down people will start to move more, and that may be starting to happen.”
When that happens, “You’ve got a seller, but you’ve also got a new buyer in most cases,” Powell said. “So it’s not clear how much additional demand would be needed.”
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