Drastic rate cuts by the Fed should ease mortgage rates even more
With the stock market crashing daily, Wall Street and Main Street look to the Fed for a series of interest rate cuts this winter (although most acknowledge it's too little, too late). According to HSH, the financial data publisher, changes in the Fed Funds rate correlate poorly with changes in mortgage rates:
Indeed, according to Dan Green, Bankrate's Mortgage Rate Trend survey states 62% believe mortgage rates will increase even though the Fed is expected to cut rates, even a dramatic 75 point cut on January 29. Last week, Inman News' Lou Barnes also states: Dramatic Fed cuts would hike mortgage rates.
However, history says that when the Fed cuts rates drastically, mortgage rates also inevitably drop (an eyeball perusal shows this).
And mortgage rates are plunging now (50 bp in a month!) - , today's 30-year fixed rate is at the same level as it was in July 2005.
Simple facts: the
housing market needs the boost from lower mortgage rates, lenders need
to lend... am I contrarian to think mortgage rates could be even lower
towards the spring? It would stimulate transactional activity;
yesterday's USAToday states that mortgage applications hit a seasonally adjusted four year peak due to falling mortgage rates.
Thanks for the link, Pat.
You say: "However, history says that when the Fed cuts rates drastically, mortgage rates also inevitably drop."
That statement may APPEAR to be correct, but it's hard to tell if there is an EXACT relationship.
Mortgage rates are "born" from the price of mortgage bonds and bonds tend to do well in times of economic weakness.
When bonds are in demand, their prices increase and that pushes yield/rates down.
Economic weakness is also one reason why the Federal Reserve would lower the Fed Funds Rate. This happens independent from what is going on in the mortgage bond market.
So, it's not strange to see that mortgage rates fall when the FFR falls. It's just that the correlation is with the MARKET and not with each other.
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I agree that rates will drop. My guess is that mortgage bonds will get worse when the announcement comes (the stock market will go wild, though), but the downward trend will continue shortly after, as the markets look toward what happens next.
The argument for rates rising after the Fed lowers their rates is that this move will hurt the dollar and fuel inflation. We have some problems with inflation, mostly related to fuel and food costs, but in most slowdowns spending lessens and inflation quickly drops. I also think that foreign investors will continue to buy our bonds. Their economic success is locked in to our prospects for growth, and our ability to continue buying their products. They really have no choice but to continue propping us up.
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I think this will be one of the most interesting questions of the year. There seems to be no question that between drops in the fed funds rates, and a likely stimulus package - we will see a lot of liquidity continued to be poured into the market.
There are some signs that this may result in "stagflation" - where the economy remains stagnant despite the stimulus, and inflation kicks into high gear.
Note that this stagflation scenario would very much indicate that right now could be the best time to buy leveraged real estate. Even if prices were to continue down in this scenario - real costs could rise as interest rates rose.
I think understanding the relationship between interest rates and price is important. Which payment is more affordable: a $500k house with a 5.5% 80% 1st, or a $400k house with a 10% 1st? I don't think the later is likely - but you don't have to look back that far in time to know it is possible.
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Pat,
Thanks for the graphs-very informative. Lately, I have been wondering how the probably rate cuts would help the market.
"However, history says that when the Fed cuts rates drastically, mortgage rates also inevitably drop (an eyeball perusal shows this)."
Helpful post.
The other question lingering in my mind is how will the stock market recession affect the real estate market. Would capitalists utilize real estate and invest their idle cash while we are in a wall street bear market? what does history say about this? I guess we'll just wait and see.
-Joe Salcedo
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