As the bond-market experiences a rally sparked by the dovish comments of Federal Reserve chairman Jerome Powell, mortgage rates may soon climb to 6.5%. While the recent survey conducted by Freddie Mac reported an average 30-year fixed mortgage rate of 6.95% for the week ending on December 14, it is important to recognize that these rates typically lag behind changes in the bond market, which ultimately determines mortgage rates.
The yields on 10-year Treasuries and 30-year mortgage securities issued by Freddie Mac and Fannie Mae play a crucial role in determining mortgage rates. This is due to the fact that a significant portion of U.S. originators’ 30-year fixed-rate loans are packaged into mortgage securities, which are predominantly sold to banks, insurers, pension funds, and other institutional investors.
According to Mortgage News Daily, the average rate for a 30-year fixed mortgage was recorded at 6.64% on Tuesday.
For the foreseeable future, Harley Bassman, a managing partner at Simplify Asset Management and an expert in mortgage securities, predicts that 30-year mortgage rates will stabilize at around 6.5%, assuming the 10-year Treasury rate remains near the current level of 4%. Presently, the 10-year Treasury yield stands at 3.9%.
Comparatively, a year ago, when Treasury 10-year yields were similar to their current levels, 30-year mortgage rates were hovering around 6.4%, as reported by Freddie Mac.
Since Powell and the Federal Reserve hinted at potential interest rate cuts in 2024 — projecting a decrease of half to three quarters of a percentage point from the current rate of approximately 5.35% — the 10-year note yield has already declined by about a quarter percentage point. Bond market participants are now expecting further reductions, envisioning short rates dropping to 4% by the end of 2024.
Mortgage Rates on the Decline
Mortgage rates have recently experienced a significant decline, dropping from a peak of nearly 8% in October. This notable decrease can be attributed to various factors, including a one-percentage-point decrease in the 10-year Treasury yield and a half-point tightening in the spread of Fannie Mae and Freddie Mac 30-year mortgage securities relative to the 10-year Treasury yield, bringing it to approximately 1.4 percentage points.
According to Bassman, the impact of lower Treasury yields and tighter mortgage/Treasury spreads takes some time to filter through the mortgage origination system. Due to the possibility of a short-term blip in Treasury yields, mortgage originators are hesitant to immediately lower their rates.
The current spread of 1.4 percentage points between mortgage securities and the 10-year Treasury yield is slightly higher than the long-term average. However, if the inversion of the yield curve shifts toward a more normal positive slope, this spread could tighten, resulting in lower mortgage rates. This scenario could potentially unfold in the next year if the Federal Reserve decides to decrease short rates by a percentage point or more.
To further understand this relationship, consider that the yield on two-year Treasuries is currently at a rate of 4.45%, which surpasses the 3.9% rate on the 10-year Treasury. This discrepancy impacts mortgage rates due to the mathematical calculations involved in creating derivative mortgage securities. Shorter-term mortgage derivatives are priced based on two-year to five-year Treasuries, and higher yields on these securities consequently increase the overall yield on the underlying 30-year mortgage securities.
It is important to note that this information is subject to change as market conditions evolve.