The correction in the housing market takes an unexpected turn

The Federal Reserve has a simple fight against inflation playbook. It works like this: Continue to apply upward pressure on interest rates until business and consumer spending across the economy weakens and inflation falls.

Historically speaking, the Fed’s fight against inflation playbook has always hit the US housing market particularly hard. When it comes to real estate transactions, monthly payments are everything. And when mortgage rates go up, which happens as soon as the Fed targets inflation, those payments go up for new borrowers. This explains why as mortgage rates rose this spring, the housing market slipped into a housing slowdown.

But that real estate correction may soon lose some steam.

Over the past week, mortgage rates have fallen rapidly. As of Tuesday, the average 30-year mortgage rate stands at 5.05%, down from June when mortgage rates peaked at 6.28%. Those falling mortgage rates give immediate relief to sidelined homebuyers. If a borrower took out a $ 500,000 mortgage at a 6.28% rate in June, he would pay $ 3,088 a month in principal and interest. At a 5.05% rate, that payout would be just $ 2,699. Over the 30-year loan is a savings of $ 140,000.

What is happening? With weaker economic data, financial markets are pricing in a 2023 recession. This is putting downward pressure on mortgage rates.

“The bond market is pricing in a high probability of a recession next year and that the downturn will prompt the Fed to reverse course and cut [Federal Funds] rates, ”says Mark Zandi, chief economist at Moody’s Analytics Fortune.

While the Fed does not fix mortgage rates directly, its policies affect how financial markets rate both the 10-year Treasury yield and mortgage rates. Pending a hike in the federal funds rate and a tightening of monetary policy, financial markets are raising both the 10-year Treasury yield and mortgage rates. Pending a reduction in the federal funds rate and a monetary easing, financial markets are pricing both the 10-year Treasury yield and mortgage rates down. The latter is what we are now seeing in the financial markets.

As mortgage rates rose earlier this year, tens of millions of Americans have lost mortgage eligibility. However, as mortgage rates begin to fall, millions of Americans are regaining access to mortgages. That’s why so many real estate professionals are cheering on lower mortgage rates – they should help boost home buying activity.

While lower mortgage rates will undoubtedly push more fringe buyers to return to open homes, don’t think about the end of the housing correction just yet.

“The bottom line is that the recent drop in mortgage rates will help margin, but the housing market will remain under pressure with mortgage rates at 5% (less sales, slowing home price growth),” wrote Bill McBride, author of economics. Calculated Risk blog, in its Tuesday newsletter. The reason? Even with mortgage rates falling by one percentage point, the affordability of housing remains historically low.

“If we include the rise in house prices, payments increase by more than 50% year-over-year for the same house,” writes McBride.

There is another reason why real estate bulls shouldn’t be too confident: if recession fears, which are helping to drive mortgage rates down, were corrected, it would cause the sector to weaken further. If someone is afraid of losing their job, they won’t enter the real estate market.

“While lower rates in themselves are good for housing, this is not the case when accompanied by a recession and rapidly rising unemployment,” says Zandi. Fortune.

Where will mortgage rates go from here?

Bank of America researchers believe there is a possibility that the 10-year Treasury yield could slide from 2.7% to 2.0% over the next 12 months. This could bring mortgage rates down between 4% and 4.5%. (The mortgage rate trajectory is closely related to the 10-year Treasury yield trajectory.)

But there is a big wild card: the Federal Reserve.

The Fed clearly wants to slow down the housing market. The pandemic housing boom, during which house prices rose 42% and construction peaked in 16 years, was among the drivers of skyrocketing inflation. Reduced home sales and a drop in construction should provide relief for the overstretched US housing supply. We are already seeing it: the collapse of the beginnings of housing is translating into a reduction in demand for everything from frame timber to cabinets to windows.

But if mortgage rates fall too quickly, a resurgent housing market could ruin the Fed’s fight against inflation. If that happens, the Fed has more than enough monetary “firepower” to exert upward pressure once again. mortgage rates.

“Whether or not we’re technically in a recession doesn’t change my analysis. I’m focused on inflation data … And so far, inflation continues to surprise us on the upside, “Neel Kashkari, chairman of the Federal Reserve Bank of Minneapolis, told CBS on Sunday.” We are committed to reducing inflation, and we will. what we have to do “.

Want to stay up to date on the housing recession? Follow me on Twitter at @NewsLambert.

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