The Fed Finally Pivots on Interest Rates…But Will It Impact Housing?

Filed in Author: Ryan, Market Updates 
October 10, 2024

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How will the Fed’s rate cut impact housing? The 3 questions that matter…

Housing Impact # 1. Will mortgage rates come down?

    Yes, mortgage rates will come down, although they are likely to come down slower than homebuyers would hope and it is not likely to be a straight path down. The Fed has for months been providing the market with ‘forward guidance’ that they plan to begin cutting interest rates and the mortgage rates have already ‘priced in’ or already reflect this expectation. In fact, mortgage rates have come down quite a bit over the last year. National average rates on the 30y fixed topped at 7.9% in October 2023. This was about a month and a half before the Fed communicated that it was expecting to cut interest rates in 2024. Even though the Fed had not actually cut interest rates at all until September 2024, mortgage rates dropped from from 7.9% to 6.4% as the mortgage market has been expecting the rate cut.

    (SOURCE: https://www.bankrate.com/mortgages/mortgage-rates/)

    Mortgages are generally priced off of a combination of the 10-year treasury yield and a spread, or premium on top of the 10-year treasury yield. The mortgage rate that buyers and refinances pay is a combination of the these two factors. The 10-Year treasury yield peaked on Oct 19, 2023 at 4.98%. Mortgages were peaking at 7.89% at about the same time meaning the spread was almost 3% above the 10-year treasury. This is a very high spread, only matched by the spread during the 2008/2009 Global Financial Crisis. To put the spread in a historical context. During the 1990s the spread ranged from 1.3% to 1.5% above the 10-Year Treasury. During the 2000s up to the Pandemic the spread generally ranged from 1.5 to 2.3%. A spread of 3% is a very high spread historically speaking. 

    In September the spread of the 30y mortgage above the 10-year treasury is about 2.5. About 2/3 of the decrease in mortgage rates of the last 12 months has been do to the 10-year treasury rate coming down and about 1/3 of the decrease in rates have been due to the spread over treasuries decreasing.  The spread tends to be a measure of economic uncertainty. When lenders are unsure of where the market is going to go, they build in a buffer with a higher spread. 

    Over the next 12 months we expect mortgage rates to come down as both the 10-year treasury yield is likely to come down as the Federal Reserve lowers their target Fed Funds Rate and as mortgage lenders feel more certainty about the market on two fronts: First, now that the Fed has begun lowering interest rates the market has some certainty on Fed policy; second, once the election resolves in November, the markets will have more certainty on the fiscal policy for the next 4 years and is likely to decrease the spread. 

    Bottom line: We expect mortgage rates to come down over the next 12 months making monthly payments more affordable for many homebuyers. Visit our website to explore how we can help you take advantage of the market with an ADU, cottage cluster or cottage home in one of our developments.

    Housing Impact # 2. Why have we seen mortgage rates go up the last month since the Fed lowered rates?

      Mortgage rates went up because the 10-year treasury yield went up. The spread of the average 30-year mortgage rate actually tightened, but the ten year treasury yield went up so much it overcame the tightening spread and mortgages went up. Review the chart below for details:

      September 18, 2024October 10, 2024
      3.70 10-Year Treasury Yield4.09 10-year Treasury Yield (37bps increase)
      6.09 30-Year average mortgage rate6.32 30-Year average Mortgage (23bps increase)
      2.39 Spread2.23 Spread

      The Fed does not control interest rates directly, they only control the Federal Funds Rate. The Fed Funds Rate is the interest rate that the Fed pays banks that hold reserves at the Federal Reserve. So even though they lowered this interest rate, the 10-year treasury went up because the Fed doesn’t control it. Investors buying and selling treasuries control the treasury yield.

      Why did the 10-year treasury yield go up? One factor was a strong jobs report was published and this caused investors buying and selling treasuries to believe the Fed might slow down future Fed Funds rate cuts for fear that inflation will pick back up.

      Housing Impact # 3. Will inflation take off again?

      Its unlikely that headline CPI inflation will take off again. The Fed’s stated goal for inflation is 2%; current CPI is at 2.4% so the Fed has not quite met their goal of decreased inflation but is already starting to lower interest rates. This leads some to speculate that inflation will take off again.

      CPI for September 2024 came in at 2.4% which was lower than August’s 2.5% but was higher than the general market expected.

      The counter to this is buried in a seemingly very small comment made by Federal Reserve Chairman Jerome Powell during the press conference announcement. He said that the Fed will continue to reduce its securities holdings. To many this didn’t mean much, but it could be the most important driver of what happens in markets over the next 12 months – even more than interest rates.

      Starting after the 2008 Global Financial Crisis (GFC) the Fed started buying bonds – mostly treasury bonds and mortgage backed securities (MBS). They did this to stabilize the market in what is referred to as quantitative easing in three initiatives nicknamed QE1, QE2, and QE3. In order to ‘buy securities’ the Fed created money and bought the securities acting as a buyer of last resort when the treasury and MBS markets were not very stable and could have collapsed. 

      Anytime the Fed creates money out of nothing and buys securities like MBS and Treasuries they are increasing the money supply and the changes in money supply matter to the economy as much as interest rates.

      The money supply is the amount of total money in the economy and is often called “M2”. The money supply is still increasing based on FRED’s report of M2 money supply.

      (SOURCE: https://fred.stlouisfed.org/series/M2SL)

      Fast and large increases in money supply are one of the primary drivers of inflation and decreases in the money supply are one of the primary drivers of recession. So the Fed is walking a tight line trying to increase the money supply at the perfect slow speed to engineer the economic ‘soft landing’.

      After peaking in 2022, the M2 money supply decreased which has only barely happened in the last 60 years. When the Fed says it is going to continue to reduce its securities holdings they are putting negative pressure on the money supply. This will balance out commercial banks that are likely to increase their lending with the Fed Funds rate coming down by 0.50%. As long as the M2 money supply remains in steady slow-growth mode the Fed and the US economy may end up with that soft landing after all. But a misstep to either side could spark inflation again or send the economy into crushing recession.

      Stay tuned!

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