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Interest rates and inflation may come down, but not mortgage rates.

Hey you! Yes, I'm talking to you...the idiot who thinks they're going to be buying a house. Not so fast dumbass.


The New Normal for Mortgage Rates Will Be Higher Than Many Hope

Changes across the market for mortgage-backed bonds mean rates can stay elevated even once the Fed starts cutting

By Telis Demos, WSJ

March 22, 2024 5:30 am ET


Interest rates are likely to come down later this year, with the Federal Reserve on track to start cutting rates. But mortgage rates might not follow as quickly.

That is because mortgages, and mortgage-backed bonds, just aren’t as in demand in financial markets as they were in the years before the Fed began to start to tighten in 2022. And they might not be for a while.


The extra yield over Treasurys—or spread—demanded by investors to own mortgage-backed securities issued by government-sponsored enterprises such as Fannie Mae or Freddie Mac, known as agency MBS, has come down a bit from the highs touched last year. But it still hasn’t narrowed back to historical levels. Wider spreads appear to be a new normal for the mortgage market. That in turn means homebuyers for now can expect to keep paying relatively higher rates.


The yield gap between mortgage bonds and Treasurys is still around 1.5 percentage points, according to figures compiled by Bank of America. The typical spread a few years ago was around 1 percentage point.


“There is further room for tightening spreads,” says David Finkelstein, chief executive and chief investment officer of Annaly Capital Management, a real-estate investment trust that invests in mortgage bonds and other strategies across residential mortgage finance. “But we don’t believe we’re going back to pre-2022 levels.”


One crucial driver of a new baseline is that the Fed seems increasingly unlikely to return to the market as a buyer of agency MBS. Even if the Fed does end quantitative tightening sooner than anticipated, many observers expect it to continue to allow mortgage bonds to mature or pay off and leave the balance sheet at the same pace, while adjusting how quickly the Treasurys part of the portfolio declines.



One Fed governor, Christopher Waller, said in a speech at the beginning of March that he “would like to see the Fed’s agency MBS holdings go to zero,” alongside a desire to shift the Fed’s portfolio to have a larger share of shorter-term Treasury bills.


“The historical [spread] level is from an environment in which the Fed was buying mortgages,” says Jeana Curro, head of agency MBS strategy at Bank of America. “We’ve had to recalibrate what is normal.”


Banks, too, hardly seem poised to return to big buying. There are still scars from last year’s crisis, which was sparked in part by banks sitting on piles of longer-term bonds such as agency MBS that plunged in value. Not only will banks’ investors probably discourage them from loading up on bonds, but regulators are considering measures such as higher capital and liquidity requirements that could have a similar effect.


Investors aren’t racing to buy mortgage bonds, either. While reallocations from money-market funds to bond funds could also spark additional demand, cash funds are still the ones seeing the biggest inflows.


Economists at Fannie Mae this week increased their forecast for average 30-year fixed mortgage rates to be 6.4% on average in the fourth quarter of 2024, from their prior view of 5.9%. They are also expecting an average rate of 6.2% in 2025. The most recent weekly average rate was 6.87%.


On Wednesday, consensus forecasts by Fed policymakers still showed that they expect three quarter-point rate cuts this year, unchanged from December’s outlook. Three Fed cuts might not be as many as some had hoped. But the central bank’s consistent messaging might at least reduce volatility in the fixed-income market, which typically helps reduce spreads.


Then there is also the role played by mortgage-makers themselves. The huge drop-off in buying and refinancing has contributed to a shrinking business, according to Fitch Ratings, citing a 35% decline from the 2021 peak in employment in the nonbank mortgage industry. The tough conditions have led “many originators to exit the market, with additional consolidation expected to occur as profitability remains constrained,” Fitch wrote recently.

What this means is that the profit spread also built into mortgage rates—on top of the yields on mortgage bonds—might not soon come down much from what it is now. At least not until there is another surge in loan volume that entices originators to expand and compete more for share.


But with so many homeowners sitting on recent mortgages at sub-3% or -4% rates, making them reluctant to sell and even less likely to refinance, such a volume wave looks remote.

In short, prospective homebuyers might get a little help from the Fed later this year. But not that much.


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