It’s a phrase I’ve already heard countless times. “When rates come down, I’ll [insert action here].”
If you’ve worked in the capital or mortgage markets, you probably know how bond yields (and mortgage rates) work. But if you’re like most people, it’s a bit opaque. Well, you’ve come to the right blog!
The federal government borrows in the capital markets for short periods of time and for quite long periods. Forty years ago, the U.S. Treasury borrowed for 30-year terms routinely. Now that’s not common; the government usually borrows for 10 years at most. And the treasury borrows most funds for shorter periods: one year, two years, six months, three months, and even overnight.
The Federal Reserve (and its chair, Jerome Powell) only has absolute control (let’s call it) over short rates – overnight, though they can exert control over long-term markets; that’s a subject for another post.
Fixed-rate mortgage pricing in the U.S. is almost exclusively set off of the 10-Year U.S. Treasury. The problem is that the government doesn’t set those rates. In fact, it has very little control over them. 10-year rates are set by the markets and expectations of future economic growth or stagnation, roughly speaking.
Current U.S. Treasury Yields for Maturities from Three Months to 30 Years
Note that in the table above, the 3-month Treasury bill is at 5.43%, while the 10-year note is at 4.22% and the 30-year bond at 4.32%. This is known as yield curve inversion and it’s not terribly common, and will likely not persist over the long term.
Back to the Fed. The Federal Funds rate is a target range set by the Fed which is the rate at which U.S. banks borrow from each other overnight (the “Discount Rate” is the rate at which banks can borrow from the Fed and it’s usually a bit lower than the Funds rate). Anyway, in its recent effort to rein in inflation, the Fed raised the Funds rate from 0% to 5.50%. Since most consumer lending is set off of short rates, borrowing slowed, so did spending, and so has inflation. Great. So rates go back down now, right? Not so fast.
The problem is that the Fed Funds rate and the 10-year Treasury rate are almost entirely unrelated. So, if Chairman Powell is indeed at the end of his tightening cycle and may even lower the Fed Funds rate next summer (as Goldman expects; see link below), this may mean almost nothing for mortgage rates.
I’ll write that again: If the Fed eases rates next summer, it may mean almost nothing for mortgage rates.
The 10-Year Treasury, off of which mortgages are indexed, is, as of this writing, more than 125 basis points (1.25%) lower than the (overnight) Fed Funds rate, at 4.23%. The markets are charging the government less to borrow for 10 years than they are to borrow overnight and get paid back tomorrow. Why? The 10-year is a bit low right now because there’s uncertainty about whether we’re heading into more of a slump or into a growth period. But most people don’t really know why the curve is so inverted right now. And that’s kinda the point.
Plausible and equally likely scenarios for the next year:
• The Fed eases 25 bp in about a year (let’s just say) and 10-year rates stay flat
• The Fed eases 25 bp and 10-year rates, by then, are higher, maybe at 5.00%
• The keeps the Funds rate at 5.50% because of other inflationary threats, and the 10-year drops
So though short rates may start to come down in the medium term, nobody really knows what the 10-year will do. Given that that rate is lower than the Fed Funds rate by more than 1%, it’s reasonable to conclude that the 10-year may be higher in a year.
If the 10-year is higher in a year, then mortgage rates will be higher, not lower.
So “I’ll wait until rates are lower” may be a long wait. It may be a 90-day wait. It may quite easily be a two-year wait. It may be a three-year wait. Nobody knows. But it is very plainly a mistake to assume that if the Fed lowers short rates, long rates will follow. They are simply not that closely correlated.
See Bloomberg’s recent story on Goldman’s rate expectations below.
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