Key Insights on Mortgage Rates and Their Driving Factors
Mortgage rates primarily follow the yield on 10-year Treasury bonds rather than the federal funds rate. However, the bond market reflects investor expectations regarding future actions of the Federal Reserve (Fed). Currently, the spread between 30-year fixed mortgage rates and the 10-year Treasury yield is wider than usual, contributing to elevated mortgage rates.
If the economy continues to slow down and the mortgage-Treasury spreads tighten, there is potential for mortgage rates to decline. In September 2024, the Fed initiated cuts to the federal funds rate after a series of increases in 2022 and 2023, yet mortgage rates have remained high. This situation highlights the complexities of the relationship between Fed actions and mortgage rates.
Mortgage rates don’t directly correlate with the Fed rate since the federal funds rate pertains to short-term borrowing between banks, while 30-year mortgage rates are longer-term rates more influenced by the bond market. They are typically calculated by adding a spread of 1.5% to 2% to the yield on the 10-year Treasury bond, which has changed in recent years due to a variety of factors.
In recent times, the spread has risen to between 2.5% and 3%, influenced by decreased demand for mortgage-backed securities (MBS) and heightened prepayment risk. With the Fed’s previous stimulus measures bolstering MBS demand during the pandemic, the ongoing lower demand has resulted in higher spreads.
Several factors keep the yield on 10-year Treasury bonds—and consequently, mortgage rates—at elevated levels:
1. Economic Strength: With a robust economy, investors often lean toward higher-yield investments, resulting in less demand for Treasuries, which in turn raises their yields.
2. Federal Reserve Policy: While the Fed can impact monetary policy, it’s ultimately the expectations of future policy that shape current mortgage rates.
3. Inflation: Continued inflation concerns prompt investors to seek higher yields on long-term bonds.
4. Government Debt: Higher levels of federal debt necessitate increased interest rates on Treasuries to maintain their attractiveness to investors.
Despite economic forecasts missing the mark regarding recession predictions, there are still expectations for a slight decline in mortgage rates through 2025. This could be facilitated by a slowdown in inflation and employment, a weak economic climate prompting higher demand for safe government bonds, and a narrowing mortgage-Treasury spread, which would signal confidence in the housing market.
In summary, while the current landscape for mortgage rates may seem challenging, there are glimmers of hope for potential relief in the future. Homebuyers and those looking to refinance can focus on the fact that fluctuations in economic conditions and investor sentiment may yet create opportunities for more favorable mortgage terms. Being adaptable and informed will be essential in navigating this evolving market.