Weekly Economic Update

Economic News:

One More Rate Increase

The future is unpredictable.

Back to the topic of higher rates for longer, as the members of the Federal Reserve Open Market Committee keep delivering a central message to the public at large through their statements. The message is that rates are not high enough to bring inflation down to where they would like. While they also say that they are willing to wait to see what the effect is of their previous rate hikes as they make their way through the economy, it seems like they are preparing us for at least one more rate hike this year.

Certainly, the bond market seems to have heard them loud and clear, as longer-term rates keep moving up in anticipation of the Fed’s next move. Plus, while the markets are still predicting that the Fed will start lowering rates next year, the number of moves forecasted downward has been narrowed. Thus, the markets are listening to the Fed and expecting higher rates for a longer period of time. And while all of this is very logical and espoused by experts, we would like to give you one familiar warning – nobody can predict the future.

We know the Fed is comprised of expert economists, but they are no better at predicting the future than other market analysts. We have already seen signs of the economy slowing down – especially within the housing market. While there are still no signs of an impending recession, this is just a reminder that the Fed did project a recession in the latter part of this year. It did not happen. And the surprising addition of over 300,000 jobs in September adds more evidence that we are not on the verge of a recession. On the other hand, this unexpectedly strong report gives the Fed plenty of ammunition for one more increase.

When Will the Spread Narrow

Possible decrease in spread with the Fed finishing its monetary tightening.

The popular 30-year, fixed mortgage rate is loosely benchmarked to the 10-year Treasury bond. Since the end of the Great Recession, the 30-year, fixed mortgage rate has on average remained 1.7 percentage points (170 basis points) higher than the 10-year Treasury bond yield. The spread in today’s market is closer to 3 percentage points. Many expect that mortgage rates will come down later this year, and that expectation is rooted in the belief that cooling inflation and more certainty about the outlook for monetary policy will result in a narrowing of the spread. However, some of the drivers of the widening of the mortgage rate spread will likely remain sticky, which may prevent mortgage rates from meaningfully declining. The spread between the 30-year, fixed mortgage rate largely reflects the risks associated with investing in mortgage-backed securities (MBS) -- plus the elements of supply and demand. For example, over the course of the pandemic, the Federal Reserve was a large buyer of mortgage-backed securities in the secondary market, generating demand that increased MBS prices and lowered yield for investors – this resulted in lower mortgage rates. Now that the Fed has backed out as a buyer, there is less demand and that has contributed to the reverse – an increase in the spread. It’s possible that the spread will decrease when the Fed finishes its monetary tightening, which could be in the coming months. That would give investors some more certainty. And, if the spread narrows, then mortgage rates could come down even if the benchmark 10-Year Treasury stays the same. But prepayment and duration risk will remain because so many homeowners remain rate-locked into much lower mortgage rates, and it’s less clear when the Fed may start lowering rates again, or what the “just right” federal funds rate level even is for this economy. Additionally, the Fed is unlikely to become a buyer of MBS again anytime soon. As a result of the sticky spread, it’s likely that mortgage rates continue to hover in the 6.5-to-7.5 percent range for the remainder of the year, which means affordability will remain a challenge for many home buyers. (Source: First American)

Fannie Mae—Recession Still Possible

Soft landing or mild recession. Which will it be?

With underlying inflation decelerating and signs that the labor market is cooling, the central question for economists remains whether the economy is headed for a soft landing or a mild recession. According to the September 2023 commentary from the Fannie Mae Economic and Strategic Research (ESR) Group, mixed signals from key economic data releases continue to muddle the near-term outlook – and the answer to that question – but a modest contraction remains the most likely outcome as consumption continues to outpace incomes and previous monetary policy tightening works its way through the system. The ESR Group notes that robust consumption growth in July was likely due to a series of temporary factors, and credit card transaction data and control group retail sales suggest real consumption growth will pull back in August. The housing market faces renewed headwinds with mortgage rates settling above 7 percent, according to the ESR Group. Still, the downside risk to total home sales is limited as more sales are being driven by life events rather than discretionary factors, and the cash share of purchases remains high. New home sales were surprisingly strong in the first half of the year, due partly to homebuilder rate buydowns, which become more expensive when mortgage rates rise. Going forward, the ESR Group expects new home sales to pull back slightly due to the higher mortgage rate environment and recent decline in homebuilder confidence. “In April 2022 we noted our expectation that the combination of dissipating stimulus impact and tightening monetary policy would result in a mild recession in the second half of 2023; mild in part because we expected the housing supply shortage to keep production from falling significantly,” said Doug Duncan, Senior Vice President and Chief Economist, Fannie Mae. “Housing production has indeed held up. However, the pandemic-related fiscal transfers and built-up household savings have supported consumer spending longer than we had expected, providing unforeseen support to the macroeconomy.

Our current prediction for a mild downturn in the first half of 2024 is predicated on the belief that consumers will begin pausing their spending, in part due to the exhaustion of those funds and having to realign to a more sustainable relationship between spending and incomes.” (Source: Fannie Mae)

Real Estate News:

Consumers Buying the Rate Down

Short term solution to high rates.

With the average 30-year, fixed-rate mortgage hitting a peak in August and September, homeowners face added affordability challenges, as reported by Freddie Mac. In response, some borrowers are turning to mortgage buydown points as a strategy to temporarily lower monthly payments, according to CoreLogic Economist Archana Pradhan. Mortgage buydown points allow homeowners to enjoy reduced monthly payments during the initial years of homeownership. For instance, on a $500,000 loan at an 8% interest rate, monthly payments would normally be around $3,670. But with a short-term rate drop to 6%, those payments can decrease to about $3,000. Notably, while mortgage buydown points offer short-term savings, interest rates incrementally increase over time.

Historically, buydown points were more prevalent prior to the Great Recession, Pradhan said. She said lenders often provided them to borrowers who might not have qualified for loans without a complete ability-to-pay verification. However, post the 2010 Dodd-Frank Act, today's mortgages have become more reliable and less risky, ensuring borrowers aren't solely qualified based on initial terms. Mortgage buydown points' popularity has surged recently as buydown activities increased notably as the average 30-year, fixed-rate mortgage surpassed the 6% mark, peaking in Dec. 2022. But with continued high interest rates, buydown point utilization has slightly dipped. On average, borrowers choosing buydown points face interest rates 17 basis points higher than those who don't, which according to Pradhan suggests some buyers are prepared to pay more upfront to ensure reduced initial monthly payments. (Source: National Mortgage Professional)