Mortgage Matters: Is Four In Store?

Trulia statistics show a softening of home prices in several hot markets. San Antonio is a leader in the downward trend. Can Austin be far behind?

By, Brian Barker

The yield on the 10-year U.S. Treasury note hovers just above 3% as we write. It hasn’t hovered this high since December 2013. Rate quotes on a prime 30-year fixed-rate conventional mortgage hover between 4.625% and 4.75%. They haven’t hovered this high in four years.

Jamie Dimon, chairman and CEO of JPMorgan Chase, believes that we’re not done yet. He sees a 4% yield on the 10-year note. Dimon didn’t say when the 4% yield will materialize. We assume (usually not a good thing to do) he means within the next year to 18 months.

Interestingly enough, the 3% yield on the 10-year note that prevailed in 2013 didn’t ratchet up to 4%. It ratcheted down to 2%. In late January 2015, the yield even briefly dropped to 1.7%. A well-timed call to a mortgage lender could have elicited a 3.625% rate quote on a prime 30-year fixed-rate mortgage.

No two epochs are alike, of course. Consumer-price inflation was dormant back then. It would remain dormant over the subsequent four years. The Federal Reserve also had the range on the federal funds rate set at 0%-to-0.25%. The effective rate was only 10 basis points.

Today, consumer-price inflation has emerged. It runs slightly above the Fed’s 2% annualized goal. The range on the fed funds rate has risen, through a series of 25- basis-point increases, to 1.5%-to-1.75%.

The effective rate is 1.7%. The range will likely be increased another 25 basis points next month. It will likely be increased another 25 basis points after that.

Given the market dynamics today, Dimon is likely more right than wrong. A 3% yield giving way to a sub-2% yield on the 10-year U.S. Treasury note is highly unlikely.

That being the case, a return to sub-4% rate quotes on a 30-year conventional mortgage is equally unlikely.

The good news is a growing economy can handle it. Like Dimon, we believe the economy, including housing, can absorb rising interest rates.

A 4% yield on the 10-year note is nothing to worry about, with one caveat.

The yield curve must remain normal. It’s normal when each successive yield on U.S. Treasury securities is higher than the previous yield.

If we see yields on short-term Treasury securities rise above yields on long-term.

Treasury securities, we might worry. At the least, we’ll contemplate the possibilities. When the yield curve inverts, short-term yields rise above long-term yields, a recession usually appears within the next 24 months.

The yield on the 10-year note is 44 basis points higher than the yield on the two- year note. The spread was 54 basis points at the start of the year. It was 100 basis points a year ago. We’re not worried, but we would like to see a little more distance separate the two securities.

Hooray for Falling Prices!

Recent data from Trulia show that home prices really don’t rise all the time.

Indeed, the data show that the median price of a home listing in six of the 100 largest markets remains unchanged or has dropped year over year. The median list price is up less than a percentage point in four other markets.

San Antonio reported the largest decline in the median list price, with a 5.4% decline. Denver, one of the hottest markets post-bubble burst, has seen only a 0.9% increase in the median list price.

The median number is a dividing number: half the listings are above and half are below the median price. It doesn’t mean every listed home in San Antonio has dropped 5.4% or that every listed home in Denver has risen 0.9%.

Trulia correctly notes that the drop in the median list price can be the result of a healthy event, such as more home builders building lower-priced homes.

The normalization of a market would be another healthy event. For instance, the median list price for a home in Honolulu is down 1.4% year over year, but it is up 18% over the past two years.

Many market watchers reflexively believe that higher is better: Rising prices are a sign of a healthy market. That’s not always the case, particularly when prices relentlessly rise above historical norms.

When that occurs, demand is eventually exhausted. A market correct, frequently unpleasant, will follow exhausted demand.

Brian Barker, BBVA Compass
A Corridor News Contributor