Almost exactly a year ago, on August 12, 2023, I wrote a post titled “Waiting for Mortgage Rates to Come Down? Examine Your Assumptions First.” At the time, the U.S. Treasury’s 10-year note, off of which mortgage rates are priced, yielded 4.22%. My contention was that given the state of things, it seemed unlikely to me that over the ensuing year, mortgage rates would drop meaningfully. Yesterday (the date I revised this article), the 10-year closed at 3.88%, a drop of a whopping 0.34% over the course of a year.
This past April, I gave a little talk here in Santa Fe about the bond markets, interest rates, mortgage rates, and how it all works. The thrust of it was that 1) with the yield curve having been inverted (with short rates higher than long rates) for as long as it had been, something was about to give, and 2) not to hold your breath for sustained and markedly lower mortgage rates, again. It’s something of a mantra, I guess.
Back when I worked in investment management, I formed pretty close working relationships with “the bond guys” because fixed income, to me, is inherently more interesting than equity analysis. One of the things you pick up on after you talk to portfolio managers over several decades is that inverted yield curves only happen about 10% of the time, on average. This most recent inversion seemed like it went on and on forever. But what’s meant by the yield curve in the first place? A chart from my talk, below, helps you visualize it.
At that time, in late April, short rates were higher than long rates and the curve had been inverted for some time, with 10- and 30-year rates lower than the overnight Fed funds rate. It was pretty clear that the market just didn’t know what to expect. The 10-year yield was then at 4.67% versus 3.88% as of yesterday, August 19, 2024.
Normally, an inverted curve is seen as a harbinger of a coming recession. Why? Because interest rates are a measure of risk. It’s always inherently riskier to borrow for longer periods of time. But if you think something ugly and terrible is going to happen in the short term, you might insist on an abnormally high short-term rate to lend someone your money. And if that’s the case, long rates might appear perfectly reasonable, but short rates high. So inverted yield curves are not an indicator of short-term economic confidence. That’s where we’ve been. The yield curve has been predicting ugly things for a while now.
If you go back a few decades (below, back to 1975) and look at a graph of all the time periods the yield curve has been inverted, you see a consistent pattern. Recessions always follow long periods of inverted curves. Look closely look at the chart, in which recessions are depicted via the grey bars. It is a near-perfect indicator.
Importantly, it happens afterwards, when the curve is beginning to flatten and normalize. And when the curve finally does normalize, recessions follow.
So that’s where we are now, with the curve flattening.
Right on cue, we got some bad numbers a couple of weeks ago. Job creation slowed and the unemployment rate (a somewhat problematic calculation admittedly) crept up, among other things. But at the moment it’s a fairly balanced picture with some strong data coming in also. With inflation under control and mixed data beginning to trickle in, the market is now asking “Why are short rates at 5.25% to 5.50% now?” And indeed the Fed seems poised to cut the funds rate by 25 or 50 basis points in its September meeting. So, the flattening and the end of the inversion seems to be upon us.
What might happen with mortgage rates over the next six months or one year, as more data comes in? What are the odds, I asked, of 10-year levels declining below 4.00% and staying there, taking mortgage rates down to 6.65% and lower? (A typical spread between the 10-year yield and a national average mortgage rate is 265 basis points or 2.65%. If, for the sake of argument, you assume the 10-year yield is around 4.00%, give or take 15 basis points, that puts a national average for mortgage rates at 6.65% or so.) My thought back in late April (when these charts were done) was that it seemed unlikely that the 10-year would stay below 4.00% for long. I still believe that’s the case, but short spells with mortgages at 6.45% or so seem likely.
So to reiterate: if we assume the Fed’s going to cut by 25 or 50 bp in September at its next meeting and recession may be on the way, what does that mean for mortgage rates over the next six months to one year?
“Not a hell of a lot” would be my answer for now.
Why?
The bond market has already priced in the Fed cut by pushing long-term yields lower, so that when a rate cut actually happens, 10-year rates might actually rise a bit. And if the 10-year Treasury stays in a trading range between 3.80% and 4.50%, that puts mortgage rates at 6.45% to 7.15% between now and the end of the year. Again, not much.
The rate scenario seems pretty clear to me.
The more interesting question to which there is no evident answer now is how much of an overall economic slowdown we’ll see, and what THAT may mean for housing markets nationally and in Santa Fe. Another big question is how much of a softening of housing demand we might we see as a result of the recent regulatory changes in real estate. My informed guess on the latter question (based on my recent experience working with buyers) is that that softening may be significant as buyers hesitate and grapple with the changes, and that we may see much more of a buyer’s market — with much more supply. We don’t yet know a firm answer to either of these questions, but by year end, we will.
In the meantime, again, I might not expect magic things to happen to mortgage rates over the medium term and would caution that if the 10-year yield climbs (a fairly likely eventuality) a slight uptick in rates would be expected. For now, though, I imagine we have seen something of a short-term bottom.
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