There’s an overwhelming amount of data and headlines circulating. This column is my attempt to make sense of it all for you, the real estate professional, from an overall economic standpoint.
A couple of months ago, I recorded a video to share my thoughts on conventional mortgage rates at a time when COVID-19 had started hitting the U.S. economy and we were seeing some massive swings in both mortgage and Treasury rates over a very short period of time.
Well, things have settled down a little since then, so I thought it would be a good time to revisit the topic and give you, hopefully, a clearer view as to where I see mortgage rates moving for the rest of this year — plus, my long-term forecast for 2021.
So, what’s been happening since we last took a look at rates?
Well, they really haven’t moved that much. When I last spoke to you, they were averaging about 3.3 percent, and they are now at 3.15 percent. Hardly exciting! But it did tell me that the Federal Reserve was successful when it decided to step in to support the U.S. economy as COVID-19 was ramping up.
But the question now becomes how much further down the rabbit hole of supporting the economy and housing is the Fed prepared to go?
As I was thinking about this, I took a look at the Fed’s balance sheet, and the figures are staggering. Today, the Fed holds about $4 trillion in bonds and $1.8 trillion in mortgage-backed securities. Their post-COVID-19 shopping spree has been aggressive, having purchased about $460 billion of mortgage-backed securities since the middle of March in support of both the economy and mortgage markets.
But I looked at the last 10-year Treasury auction, and although the Fed purchased about $35 billion worth of 10-year paper, that was down from the $40 billion they spent at the prior auction.
So this begs the question as to whether this is a sign that they will continue to limit their purchases and, if so, what will this mean for mortgage rates?
As many of you will know, mortgage rates are heavily influenced by the interest rate on government securities with 30-year rates tracking the 10-year Treasury rate remarkably closely — or it did, but I’ll get to that part shortly.
You know that I do like to offer a little perspective when I share my thoughts with you, so let’s take a quick look back in history and how mortgage rates have moved over time.
The chart in today’s video shows conforming 30-year fixed-rate mortgages going all the way back to when they first came in being back in the mid-1970’s.
First off, I need tip my hat to my colleague Leonard Kiefer over at Freddie Mac who first came up with looking at rates this way. I think that it tells a great story.
You can clearly see the trajectory of rates over time with a peak at just below 20 percent back in the ’80s followed by a downward trend all the way to the 2020 average of 3.5 percent. It’s a truly remarkable drop in borrowing cost.
What can we expect for mortgage rates going forward?
The Fed is very influential when it comes to the interest rate on mortgages as they can influence them by buying, or not buying, Treasurys, but I just don’t see them limiting their purchases any time soon. Chair Jerome Powell has been very direct in stating the Fed’s unwavering support of the economy but, additionally, I see the Fed continuing to buy debt because of the U.S. Treasury.
You see, last month, the Treasury announced that it would need to borrow another $3 trillion before the end of June. This is a massive figure. For context, it’s six times the amount it borrowed in the first quarter of this year and almost triple the amount the Treasury borrowed for the whole of the 2019 fiscal year.
And to fund this borrowing, the agency said it would boost the size of its auctions of three, 10 and 30-year bonds to record amounts. I just don’t see the Fed pulling back too much because of their fear that if they aren’t active buyers, rates might rise as that could hurt the economic recovery.
So, if the Fed remains as a buyer, what will happen to mortgage rates? Well, I mentioned earlier how important bonds — especially 10-year Treasurys — are to calculating mortgage rates.
Interest rates for 30-year fixed-rate mortgages and 10-year Treasurys track each other almost perfectly. Or they did, up until March when the relationship went off the rails because of COVID-19.
When the virus appeared, the Fed moved swiftly to support the economy by firing up the printing presses (yup, QE4) and buying a lot of debt in the form of bonds. This led interest rates to drop, but mortgage rates didn’t really react that much — at least they haven’t so far.
The average interest rate on a new 30-year fixed mortgage in May has fallen to 3.15 percent. That is the lowest rate since Freddie Mac started tracking the data a half century ago, but it’s not significantly lower than the old record. Now, at the same time, U.S. 10-year Treasury yield sits at just under 0.7 percent. That’s also an all-time low but it’s almost a full percentage point lower than the old record. That’s huge.
The spread between mortgages and the benchmark rate averages 1.7, but today, it’s at 2.5 percent (because bond yields plummeted). It has only been wider once, and that was during the financial crisis. Therefore, it’s not unreasonable to suggest that even if bond yields remain static, mortgage rates could actually be a lot lower than they are.
So, why aren’t they?
One reason is a simple imbalance between supply and demand. As interest rates started falling in March, there was a flood of refinance applications, and lenders struggled to work through this pipeline.
In essence, there was so much demand there that originators were able to keep rates a little higher than they should have been.
But the pipeline is being worked through, and refinance applications have slowed, so we are likely to see originators becoming more competitive.
So what does this mean for rates? Well, if you’ve been hearing whispers of 30-year fixed rates in the high 2 percent range, maybe you shouldn’t shake your head and scoff at the prospect, because this could really be the new reality for rates.
If we consider the outlook for economic growth and inflation — two key considerations for interest rates — it’s not too much of a stretch to believe that we could, and should, be at rates significantly lower than the levels we see today.
As I was putting my thoughts together, I took a look at other economists’ forecasts to see where they are forecasting rates, and here are their expectations (along with mine) for the second half of this year.
Both the National Association of Realtors and Wells Fargo Bank are predicting rates breaking south of 3 percent. These forecasts clearly suggest that the Fed will continue to buy bonds as needed, and rates are set to drop.
Well, I’m afraid that I just can’t get my head around sub-3 percent mortgages quite yet, but others certainly see it as a real possibility, and their math actually does hold water.
You see, if you look at where 10-year Treasury rates are today, and knowing the average spread between 10-year paper and 30-year rates is 1.7 percent, add those two numbers together, and it implies a mortgage rate of around 2.6 percent.
As for my longer-range forecast for rates, I am very comfortable in saying that we will remain in the very low 3 percent range until 2022 at the earliest.
So, there you have it. I still expect to see rates stay remarkably low for quite some time, and this obviously bodes well for the U.S. housing market as we move through the current economic downturn and, hopefully, into a more vibrant economy in 2021.
Matthew Gardner is the chief economist for Windermere Real Estate, the second largest regional real estate company in the nation. Listen to him speak at Inman Connect Now.
