A year ago, you could find a 30-year fixed rate mortgage for under 3%. Today, it is over 5%. The 30-year benchmark mortgage rate primarily reflects two components: the yield on intermediate- to longer-term Treasury securities and a spread that fluctuates over time.
The Federal Reserve has held Agency mortgage-backed securities (MBS) on its balance sheet since early 2009 and Fed purchases of these securities have pulled down the yield on the benchmark 30-year MBS by an estimated average of 50 basis points since that time.
Even though Fed officials have indicated they will allow their MBS holdings to decline in coming months, this will not necessarily cause further upward movement of mortgage rates, as markets are forward-looking. There is a significant amount of near-term monetary policy tightening already priced into the market. To some extent, the recent mortgage spread widening is consistent with markets accounting for smaller Federal Reserve MBS holdings going forward.
Additionally, Fed MBS purchases in recent years have pulled MBS yields lower than actual mortgage rates, meaning it is reasonable to expect that MBS yields will face more upward pressure than actual mortgage rates as balance sheet runoff progresses. Longer-term, markets appear priced for a fed funds rate that is closer to “neutral.”
Mortgage rates are separate from Treasury yields, but it is still fair to ask how much higher the yield on the 10-year Treasury note will rise. There is always the potential that yields on U.S. Treasury securities could rise even further, but the recent surge in the 10-year Treasury yield is expected to slow markedly in the coming weeks, which should dampen upward pressure on mortgage rates.
There are wide confidence intervals around estimates for both the timing and the magnitude of the impact from balance sheet runoff, and it is unlikely balance sheet runoff has been fully priced in yet. Odds are it is discounted by more than many might suspect, given that the process has not even yet begun. The past several months have shown that the economic outlook and expected path of monetary policy can change rapidly.
History suggests the Fed will struggle to tighten financial conditions enough to cool inflation without causing an economic contraction. While inflation is actually an indication that an economy is growing too rapidly relative to the supply of labor and other resources, the danger is that rapidly rising prices can prompt policymakers to slam the brakes on the economy.
The fear is that the Fed has not acted quickly enough to get inflation under control, which now forces it into taking really drastic actions (e.g., large interest-rate hikes) which would go further than merely slowing down the economy, but plunge it into a deep recession, à la the early 1980s. The hope is that the Fed still has a decent chance of cooling down the economy and bringing down inflation without causing a recession, which is known as a “soft landing.”
All that being said, the economic outlook is highly uncertain, and mortgage rates could move higher than expectations to re-establish price stability. With a lot of sharp moves in the market, it helps to have actionable recommendations to protect your business and pipeline. Check out our most recent webinar Taper Tantrum Two? Comparing 2013 to 2022 & What Lenders Can Do. In this webinar, Phil Rasori, Justin Grant, and Andrew Rhodes compared 2013 to 2022 in terms of the deteriorating market, market liquidity in specific coupons, loan sale execution liquidity, and investor pricing performance.