Let’s start back in 1938, yes, that far back!
“Prepare for the unknown by studying how others in the past have coped with the unforeseeable and the unpredictable.” – George S. Patton
I believe many aspiring homebuyers feel like the housing market is at war with their American Dream, so Patton’s quote could be appropriate. And yes, though we will dissect historic context and potential outcomes in this article, mortgage rates are truly unforeseeable and unpredictable. The Flagstaff Housing market has vacillated, with around 75-80% of buyers financing vs. cash. This makes a vast majority of our buyer base not only sensitive to prices but also to the cost of financing. This last decade will go down as a case study of fiscal policy action and reaction, with rates hitting 70-year lows with then a historically fast approximate six-month run-up to 25-year highs. My attempt here is to review the broader past to help us determine, as Patton advises, how mortgage rates responded to historic events and how they will respond to the history we will yet write in the coming months and years.
Let’s start back in 1938, yes, that far back! I’ll admit, we’re going to get into the weeds, but bear with me, it will be worth the journey! In 1938, the secondary mortgage market was created by Congress in a way to create liquidity for originating lenders. Mortgages could be originated and sold so that local banks could originate more local mortgages. We’ll fast-forward dramatically to the 1980s when the securitization of that market occurred, creating mortgage-backed securities. Since that time, the majority of residential mortgages are originated and sold as a security on the bond market. The supply and demand of that bond market holds a direct relationship to mortgage rates.
America is the home of the 30-year fixed mortgage, with 90% of the market selecting this term. This makes the mortgage-backed security a long-term instrument. Long-term instruments do not like inflation. Sure, as a homeowner, you love your fixed mortgage but a fixed rate of return on a long-term investment in an economy where your dollar value is eroding is not the preferred side of the stick to be on. Our lesson in history below shows that in the last two large inflation cycles, rates rose as a direct result of inflation. The big key to understand though is that inflation is a lagging indicator. Think of this most recent cycle – money was being printed, the housing market flying off the rails and months, if not close to a year, down the road we see inflation reports stare us down with consequence of our previous month’s actions. Rates then historically lag to inflation, with mortgage rates beating on sub-4% until the start of 2022, when CPI was already 7.5%.
This lag effect then plays heavily into why we haven’t seen mortgage rates lower already with inflation coming down significantly from its peak in 2022 but rates peaking again at 25-year highs just last month. The other elephant in the room causing delay is the Fed. Markets aren’t so confident that they truly have a handle on inflation and investors of mortgage-backed securities remain hesitant given the market volatility.
I won’t be so bold to tell you by how much and when mortgage rates will reduce but I can give you some broad strokes to help you connect your own dots. Inflation will eventually come under control. Sustainable inflation levels will remove volatility, which will allow the purchasers of mortgage-backed securities to better forecast futures. With time, we will then likely see normal market spreads return. What that means is that historically, mortgage rates trend around 1.75% above the U.S. 10-year Treasury Yield. Right now, mortgage rates are well over 3% above that yield, which historically only occurs in times of high volatility. If we saw a 1.75% spread today, we would see a 30-year fixed rate in the mid- to high- 5% range.
Mortgage rates will likely not be an exemption to historic repetition. While we certainly won’t be repeating 2% any time soon, the Northern Arizona owner and prospective buyer can rest assured, normalcy will eventually prevail. FBN
By Chris Hallows
For additional information or to schedule an appointment, visit ChrisHallows.Benchmark.us or call 928-707-8572. The Flagstaff location is 824 W Rte 66 Suite A-3. Chris Hallows is the Branch Manager & Sr. Mortgage Advisor of Benchmark Mortgage Flagstaff. NMLS 306345 Ark-La-Tex Financial Services, LLC NMLS 2143 |Equal Housing Lender
