To combat inflation, the Federal Reserve employs a straightforward strategy. If you keep raising interest rates until the economy slows and inflation drops, you’ll see a drop in inflation. U.S. housing markets have been particularly heavily affected by the Federal Reserve’s inflation-fighting tactics.
Regarding real estate deals, monthly payments are the most important. When mortgage rates rise, new borrowers face higher monthly payments. This occurs whenever the Federal Reserve takes action to combat inflation. This spring’s rise in mortgage rates triggered a home market slowdown.
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Housing prices may soon stabilize, but that may not last long. Mortgage rates have fallen significantly in the last week. The average 30-year fixed mortgage rate was 5.05 percent as of Tuesday, down from 6.28 percent in June, when rates peaked. Reduced mortgage rates are a welcome relief for prospective homebuyers who have been on the fence.
Using June’s 6.28 percent interest rate, someone who took out a $500,000 mortgage would pay $3,088 monthly in principal and interest. A 5.05 percent interest rate would bring the total cost down to $2,699. That works out to a savings of $140,000 over the length of the 30-year loan.
What’s going on here? Financial markets are pricing in a recession beginning in 2023 as economic data continues to deteriorate. As a result, interest rates on home loans are going down.
“The bond market is pricing in a high possibility of a recession next year, and that the downturn would compel the Fed to reverse direction and decrease [Federal Funds] rates,” says Mark Zandi, chief economist of Moody’s Analytics, in an interview with Fortune magazine. Federal Reserve policies have a direct impact on both the 10-year Treasury yield and mortgage rates, even though they don’t directly set them.
Bond and mortgage rates rise as investors anticipate a rise in the Federal Funds rate and further tightening economic policy. Ten-year Treasuries are being priced lower, while mortgage rates are discounted in anticipation of lower Federal Funds rates and more stimulus. Financial markets are currently experiencing the latter.
Tens of millions of Americans became ineligible for mortgages early this year when interest rates rose. Millions of Americans are regaining access to home loans, though, as mortgage rates begin to fall. The fact that mortgage rates are going down is good news for homebuyers, which is why so many in the industry are excited about it.
Don’t expect the housing crisis to be over, even though reduced mortgage rates will likely bring more buyers back to open houses. As a result, despite the recent drop in mortgage rates, Bill McBride, creator of the economics blog Calculated Risk, predicted that the housing market would stay under pressure with rates at 5% (fewer sales, slower house price growth).
Why is this so? Housing affordability is still historically poor, despite a one-percentage-point decline in mortgage rates. This year’s payment increases on the same house were more than 50% higher, according to McBride.
Some additional weakening could occur in the housing sector if recession fears, which are driving mortgage rates lower, are correct. This is another reason for housing bulls to be cautious. Fear of losing a job prevents people from entering the housing market.
When coupled with a recession and rapidly growing unemployment, lower rates benefit housing, but Zandi tells Fortune that this isn’t the case.
What will Happen to Mortgage Rates in the Future?
Based on their forecasts, the 10-year Treasury yield might fall from 2.7 percent to 2.0 percent in the next year; according to Bank of America analysts, Between 4% and 4.5 percent mortgage rates could be possible. Rates for 30-year mortgages tend to move in tandem with the yield on the 10-year Treasury note.
An explicit goal of the Federal Reserve is to slow the housing market. Inflation has been fueled by the global housing bubble, which saw home prices rise 42 percent and homebuilding set a 16-year high. To alleviate the overstressed U.S. housing supply, lower home sales and less construction are expected.
Already, we’re seeing a decrease in demand for everything from framing timber and cabinetry to windows and doors. A recovering housing market could wreak havoc on the Fed’s efforts to control inflation if mortgage rates decrease too quickly. In the event of it, the Federal Reserve can once again raise mortgage rates.
It doesn’t matter if we’re in a recession or not if I’m wrong. Focusing on inflation data is where my attention is right now… We’re still getting surprises from inflation, which is encouraging,” Minneapolis Federal Reserve Bank President Neel Kashkari told CBS Sunday. There is no doubt in my mind that we will do everything we can to keep inflation down.