The 5 Percent Rate Quote: Sooner Or Later?

Inflation influences the long end of the yield curve more than the short end. We’ve seen the yield on the 10-year U.S. Treasury note rise 60 basis points over the past three months. That’s a 25% increase…

by, Brain Barker

A four-year high, at least that’s the Mortgage News Daily verdict. Rate quotes on the prime conventional 30-year mortgage center on 4.625 % – a four-year high – more often than not these days. Rate quotes clicked higher after the minutes of the latest meeting of Federal Reserve officials were released. The minutes showed officials were more upbeat on the economy than most market watchers expected.

Fed officials expect U.S. gross domestic product (GDP) to grow at a 2.5% annualized in 2018. The growth rate is considered bullish. The bullish outlook, in turn, increases the likelihood of at least two more increases in the federal funds rate.

The federal funds rate is an overnight lending rate. Its impact on long-term lending rates can be minimal, as it has been in the recent past. The prospect of strong GDP growth stoking inflation fears is another story. Consumer-price inflation posted its largest increase in a year in January. Rates on the long-end of the rate curve have been rising.

Inflation influences the long end of the yield curve more than the short end. We’ve seen the yield on the 10-year U.S. Treasury note rise 60 basis points over the past three months. That’s a 25% increase. Rates on the prime 30-year loan are up roughly 12% over the same period.

The trend in mortgage rates has been up, to state the obvious. Does that mean it will continue to be up?

Inflation, again, is key. If consumer-price inflation comes in hot over the next couple months, long-term interest rates will trend higher. But it’s not a done deal. Consumer-price inflation was hotter than expected than January, but it was still (at the core) below the Fed’s target rate of 2% annualized growth.

We’ve seen the yield on the 10-year Treasury note actually level off in the past few days. Quotes on mortgage rates have also leveled off. Stock-market volatility has some investors seeking havens. Treasury securities are preferred havens. We’ve seen some firming of Treasury prices.  We’ve seen some firming of mortgage-rate quotes.

It’s also worth noting that the Fed continues to support the mortgage market.   The Fed holds roughly $4.4 trillion of assets on its balance sheet. Most of these assets comprise Treasury securities and mortgage-backed securities (MBS). The Fed has said it would like to “normalize” its balance sheet. In other words, the Fed would like to reduce its asset holdings. (Before the 2008 financial crisis, the Fed owned roughly $870 billion of assets, mostly short-term Treasury bills.)

The fact is, though, the Fed continues to hold a lot of MBS. There has been only a slight decline since the Fed announced in October that it wanted to wind down its balance sheet. Its MBS holdings had drifted slightly lower. They’ve drifted higher in recent weeks. The dollar value of the Fed’s MBS holdings is about where it was in October. The Fed is no rush to normalize.

So, what about mortgage rates? If by “later,” we mean the second half of 2018 for a 5% rate quote to materialize on the 30-year loan, we would bet later. Fortunately, no one forces our hand.

Business as Usual

We could call it a tale of two markets. We have the new-home market where optimism dominates. Home builders, in particular, are optimistic. Confidence, as measured by the home builder sentiment index, continues to hover near a decade high. Confidence is backed by activity. Housing starts continue to trend higher, with starts posting at 1.326 million on an annualized rate in January. Capacity is the leading challenge these days. Builders struggle to meet strong demand.

We also have the existing-home market, where stagnation dominates. Existing- home sales were down in January, falling 3.2% to 5.38 million on an annualized rate. The decline was led by the multi-family component, but the single-family component also reported a decline. The dual culprits of low supply and rising prices are again to blame for lack of sales growth.

Higher mortgage rates have taken some steam out of the market. Purchase activity has waned in recent weeks. The good news is that Realtors continue to report strong traffic, so the interest is there. Buyer interest occupies a higher plane, even if mortgage rates occupy a higher plane. Strong buyer interest in the face of rising financing costs speaks well to underlying housing fundamentals.

Brian Barker, Contributor
BBVA Compass