WHY ARE MORTGAGE RATES MOVING UP? WITH THE FEDERAL RESERVE CUTTING RATES, AREN'T MORTGAGE RATES SUPPOSED TO BE COMING DOWN?
Authors:
Consensus belief heading into 2024 was that inflation was largely vanquished and that mortgage rates would be falling back to pre-pandemic levels (in the 4 - 5% range), with a "soft landing" by the end of the year. That narrative does not appear to have been accurate. Mortgage rates have cooled significantly since their cycle highs from October of '23 at near 8%, however, since the Federal Reserve cut rates last month, the average 30-year fixed mortgage rate in the U.S. has ripped to the upside from just below 6% to back up around 7%.
There seems to be a widely held misconception in the public regarding the relationship between the federal funds rate and mortgage rates, in that many people are under the impression that there is a direct relationship, but that is not how it works. Mortgage-backed securities are long term debt instruments that trade in the bond market along with long-term treasuries, etc. The three primary factors that impact long-term bond yields (and their underlying prices) are relative changes to economic growth, inflation, and government policy (both anticipated and realized). Fed policy has more of an influence on short term rates than it does on long term rates. Additionally, the bond market uses evolving inflation data, growth data, and Fed sentiment to anticipate growth, inflation, and policy moves, so often by the time the Fed acts that action is already reflected in mortgage rates. An exception to that might be if the Federal Reserve makes a move that significantly differs from what the markets expect.
Sometimes the Federal Reserve comes to premature conclusions about the future trends of growth and inflation, and as a result, they make policy moves that they later end up reversing. At least for the moment, the market is disagreeing with the Fed on what the trend of interest rates will need to be.
We subscribe to economic research, analysis and investment coaching from Hedgeye Risk Management, a firm that has a long standing track record of using unbiased, apolitical, dispassionate data analysis to accurately forecast trends in GIP (growth, inflation, and policy) which has enabled them to subsequently forecast trends within specific aspects of the U.S. economy, like long-term interest rates. Since late last year, Hedgeye has been forecasting a shift to a stagflation environment (which is when we have deceleration in the rate of change in growth and acceleration in the rate of change in inflation) to begin in October/Q4 of '24 (the market starting to see this and price this data shift in is the likely cause for the recent spike in interest rates) and they had that trend lasting at least through Q2 of '25. The CPI release for October's data accelerated to 2.6% which confirmed that trend. As a result of Trump's pending inauguration and proposed economic policies, however, they are now forecasting a reflationary environment in Q1 of '25 (where growth and inflation are both accelerating), which if accurate, will likely put downward pressure on mortgage rates during the first part of next year, potentially starting to price in before that. After the brief period of reflation, they have the U.S. back in a stagflation environment starting in Q2 of '25 which, if accurate, will likely result in a continuation of the "higher for longer" interest rate regime that began in 2022, as we move into the spring/summer housing market next year.
Of course, no one can predict the future with 100% accuracy, but we have found Hedgeye to have the highest probability of accuracy of among any analyst we have followed or subscribed to, and they have been much more reliable than the economists at the Federal Reserve, the economists representing special interest groups, and the main stream media pundits at CNBC.
Rates are always an important topic when thinking about real estate because 1) they serve as a primary economic indicator and 2) even in high-end luxury markets where a majority of deals are all cash sales, the cost of capital has a major impact on the general fluidity and mobility that exists within the housing market place.
I hope this is somewhat useful to anyone trying to make mortgage related real estate plans. Please don't hesitate to reach out to us if you need someone to run scenarios with.
Sincerely,
-Nick
