ICE Fixed Income Monthly

When world leaders gathered recently in Davos, the debate largely centered around when, how long, and how severely the U.S. could expect to be in a recessionary environment as the Federal Reserve battles inflation. Wrapped within the same dialogue, was discussion of diverging national economics and the important knock-on effects on foreign exchange, along with top-of-mind issues like climate change and geopolitical dynamics. At the same time, we saw a continued tampering in the U.S. inflation print and data, suggesting that the labor market remains tight, all while employers continued to announce workforce reductions that are not yet reflected in the figures.

Given the nearly-immediate impact of interest rates on mortgage borrowing rates, we continue to look to the housing market to assess how rising interest rates are impacting this vital part of the U.S. economy, and the implications on consumer demand. The normal chain of logic follows: as interest rates increase, so too do mortgage rates, making borrowing more expensive. As a result, home buying activity is expected to decline and home prices drop, which causes a decline in consumer wealth that leads to a reduction in consumer demand. Of course, any number of factors can disrupt this chain of logic — hence our focus on the data.

One area we look to for evidence of housing market health is the second home and investment property segment. These loans are typically deemed more speculative than traditional owner-occupied loans. Interestingly, ICE Mortgage Technology? data shows clear moderation in loan application activity in states that have been “hot spots” for second homes and investment properties — think Florida, Nevada, Arizona and South Carolina.

Reviewing trends from the past few years provides further context: mortgage applications for second homes and investment properties, relative to owner-occupied properties, were somewhat muted in 2020 as the pandemic fed uncertainty. Swift rate cuts and Fed support for bond markets saw confidence rebound, with cheap money helping fuel a housing frenzy in 2021. As inflation concerns rose, the Fed kicked-off aggressive monetary policy tightening. ICE Mortgage Technology data showed a resulting change in behavior in hot-spot states on both the demand and supply side. On the demand side, investor and second home activity began to drop in 2022 as the cost of borrowing jumped, while on the supply side, underwriting for investor and second home loans in these hot-spot states has become more conservative of late, with both Loan to Value (LTV) and Debt to Income (DTI) dropping from their peaks.

Taken together, this picture seems to suggest that the Fed’s approach is working — so much so that the market has begun to temper its rate hike expectations. Mortgage rates, as measured by the ICE U.S. Residential Mortgage Rate Lock Index, have declined. As of mid-January, the ICE U.S. Conforming 30-Year Fixed Mortgage Rate Lock Index sat just north of 6%, down a full percentage point from peak levels hit in November 2022. So, while things could get worse before they get better, there are also some brighter signs ahead.

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