Key takeaways
- The Federal Reserve is expected to lower rates by at least 100 basis points through the end of 2024.
- As such, primary mortgage rates could fall by as much as 60 bps over the next year — and by even more if the rates market begins to price in more cuts than are currently expected.
- Lower mortgage rates could boost house sales, provided a weaker labor market doesn’t materially undermine consumer demand.
Persistent inflation and the “higher-for-longer” interest rate backdrop have made borrowing more expensive. This has significantly impacted U.S. mortgage rates, which hit 8% in October 2023 — the highest level since 2000. Since then, rates have hovered around 7%, recently falling to 6.44% in August on the back of recession fears.
With inflation cooling, economic growth slowing and interest rate cuts on the horizon, are mortgage rates expected to go down even more?
How far will mortgage rates go down?
J.P. Morgan Economic Research predicts the Federal Reserve (Fed) will lower rates by at least 100 basis points (bps) through the end of 2024, which should help nudge primary mortgage rates somewhat lower.
The Fed will be focused on bringing the Fed funds rate down, and most of the impact will likely be felt on the front end of the yield curve. “Mortgages typically price off of longer-term Treasuries, and so at the first order, the decline in the front end of the curve would seem to have a muted impact on mortgage rates — perhaps only around 20 bps,” said Nick Maciunas, Head of Agency MBS Research at J.P. Morgan.
However, there are two additional channels by which a steeper rate curve could result in lower primary mortgage rates. The first is by compressing the primary/secondary spread — or, the difference between the primary mortgage rate (what the borrower pays) and the secondary mortgage rate (what MBS, or mortgage-backed securities, trade at in the secondary market). “Currently, that spread is elevated by around 20 bps versus 2018 levels. If the curve re-steepens and volatility comes down, that spread could compress,” Maciunas explained.
In addition, MBS investors currently demand a premium over Treasuries to compensate for prepayment risks due to the inverted yield curve and elevated volatility. “MBS investors are short a prepayment option to borrowers. When the curve is inverted, that option is more in the money in the future, and options are more valuable when volatility is higher. A steeper curve and lower volatility could help the MBS/Treasury basis compress by another 20 to 30 bps,” Maciunas said.
“All in all, primary mortgage rates could fall by as much as 60 bps over the next year, if forwards are realized — and by even more if the rates market begins to price in more cuts than are currently expected,” Maciunas added.
Primary mortgage rates have hovered around 7%
U.S. mortgage rates peaked at 8% in October 2023 and have hovered around 7% since then.
How do mortgage rates affect the housing market?
Elevated mortgage rates have dampened home sales by reducing affordability. It has also put pressure on existing homeowners with adjustable-rate mortgages — revised once or twice a year based on current borrowing costs — who have seen their monthly payments soar.
This is reflected in recent sales data. Pending home sales — which led existing home sales by one to two months — recovered slightly from all-time-lows and increased 5% month-over-month in June, but this did little to reverse the recent weakness in the housing market. “Sales remain depressed given affordability challenges, and inventory remains well below pre-pandemic levels,” observed Abiel Reinhart, Economist at J.P. Morgan.
Indeed, overall confidence in the housing market remains fairly subdued according to the NAHB/Wells Fargo Housing Market Index (HMI), which tracks overall sentiment among builders. “The index was little changed in July, falling to 42 from 43 in June. It is down from a recent high of 51 in March/April, but since late 2022 the index has been oscillating within a range that is considerably depressed relative to pre-COVID values, consistent with the drag on the housing market from high mortgage rates,” Reinhart added.
Confidence in the housing market is subdued
The NAHB/Wells Fargo Housing Market Index (HMI) remains depressed relative to pre-COVID values.
However, the outlook for the housing market could improve if mortgage rates go down. “With interest rate expectations dropping after the July jobs report, mortgage rates could be set for a step down that would likely benefit sales later this year, provided a weaker labor market doesn’t materially undermine demand for housing,” Reinhart said.
This could, in turn, help buttress the homebuilding sector. “To the extent that interest rates stabilize, absent a medium to large recession, we expect solid book value growth alongside very strong balance sheets over the next two years,” said Michael Rehaut, Head of U.S. Homebuilding and Building Products at J.P. Morgan. “Overall, we believe the sector should continue to benefit from solid fundamentals, including a still favorable demand/supply backdrop, in particular driven by fairly tight supply across the broader housing market.”
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