Mortgage Matters: A Reprieve, Though A Temporary One

May 28, 2018

0 3 minutes read

You don’t get much longer than a 30-year mortgage. If we have modestly more inflation, we should have modestly higher mortgage rates. If the inflation is temporary, the modestly higher mortgage rates should be temporary…

By, Brian Barker

Mortgage rates took a breather this past week. Instead of ascending, as they have for most of 2018, they eased back a few basis points. The range still holds, though. Quotes on prime 30-year fixed-rate conventional mortgages remain within the 4.75%-to 4.875% range at the national level. Quotes have been more “4.75%-ish” as opposed to “4.875%-ish” in recent days.

Rate quotes on the prime 30-year loan have eased because the yield on the 10- year U.S. Treasury note has eased. The yield spiked to 3.11%, but then retreated. The yield on the 10-year note hovers around 3%. We often note that as the yield on the 10-year note goes, so go rate quotes for long-term mortgages. Such has been the case once again.

The reprieve could prove temporary

Federal Reserve officials hinted that a bit more inflation is forthcoming. They said as much in their last meeting. The minutes of the meeting reveal that “a temporary period of inflation modestly above 2% would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

We could debate the meaning of temporary and modestly. A year is temporary to a Galapagos tortoise; a second is temporary to a fruit fly. It’s all perspective based on experience and anticipation. The same goes for modestly. We’re sure Queen Elizabeth and Miley Cyrus offer differing perspectives on the word.

That said, we interpret the Fed’s statement to mean that we should expect more consumer-price inflation than we’ve seen in the past 10 years. Given the direction of energy and food prices, to argue to the contrary would be difficult. (BTW, energy and food prices are excluded from the “core” calculation of the Consumer Price Index.)

Consumer-price inflation influences interest rates. It’s most influential on long- term interest rates. You don’t get much longer than a 30-year mortgage. If we have modestly more inflation, we should have modestly higher mortgage rates. If the inflation is temporary, the modestly higher mortgage rates should be temporary.

For the present, we appear to have enough uncertainty to hold mortgage rates at the lower end of the current range.

Market participants have become edgier on the prospect of Italy leaving the European Union. The country is close to confirming a government that would like to break away.

Farther east, tensions are rising between Greece and Turkey. Turkish military jets have continually violated Greek air space over the past three months. Both countries are also fiscal basket cases. The easiest political solution is to divert everyone’s attention with an international conflagration.

We expect the lower rate quotes that have materialized over the past week to hold for a bit longer. We offer a caveat: We can’t offer a firm definition for a bit. We can’t say when modestly more inflation will hit.

As for the Supply Side of the Equation…

The demand side is the primary focus when talk turns to interest rates and housing. This doesn’t mean the supply side is immune to interest-rate movements.

While some industries are impervious to interest-rate movements, others appear vulnerable. Home builders fall into the latter category. Rising interest rates can crimp demand. They can also raise financing costs. Home builders tend to rely on debt financing more than others.

This is indeed the perception. Since the Fed began tightening the money supply, the worst performing S&P 500 sector has been real estate. Since January, the S&P Supercomposite Home Builder Index has flirted with bear-market territory.

The good news is that rising interest rates might take less of a financial toll than many analysts anticipate. Toll Brothers made money in the first quarter, though less than analysts had expected. CEO Douglas Yearley Jr. dismissed the role of rising interest rates, on both the supply and demand sides, telling analysts, “They [rising interest rate] have not impacted our business.” He went on to say, “So right now we’re very comfortable with our business and [see] no issues out there.” (Yearley Jr. cited soaring lumber prices for the earnings miss.)

Toll Brothers is a high-end builder, but we expect other builders to continue to hold their water, as well. Perspective is in order: Interest rates are rising, to be sure, but they’re still low compared to historical interest rates over the past 40 years.