Mortgage Rates Aren't As High As They Should Be...

-??Phillip Cantrell May 6, 2024

That’s a headline that opens Pandora’s box for sure. In late 2023 many loudly predicted that by the end of Q2-2024 we would be at the second Federal Reserve rate cut for this year. Despite those prognostications, the markets are now pricing a 27% probability of ZERO rate cuts In 2024. Incredibly, that's up from just 2% only 30 days ago. A 25% swing in probability scores represents an astoundingly rapid and dramatic shift in market expectations. Such a large swing in such a short period of time is extremely rare.

With inflation remaining elevated, the Federal Reserve decided to keep rates unchanged at 5.25% - 5.5% in their FOMC statement today. Which will keep the national average on a 30-year mortgage somewhere close to where it is now, at 7.25%.

At the risk of sounding like a boast, in October 2023 I told my team that we would not see a rate cut before June, and only then IF inflation cooled dramatically. As 2024 progressed and inflation did not cool, I returned to the topic to say that the earliest rate cut would be in June 2024. After today, I do not see the Fed making any rate cuts this year. Apparently 27% of the market now agrees.

Upon what did I base my predictions? My EARS. I listened to what the Fed Chair has said in previous FOMC statements. Then compared those words with previous actions. A simple but effective system that seems to baffle many.

Mortgage rates are based on the 10-year treasury, not the fed funds rate. So, some intuition is required in making the interpolation between the funds rate and mortgage rate moves. This is compounded by “risk-on / risk-off” pricing in the mortgage-backed securities market, but directional trends can be estimated by listening to what the Federal Reserve says.

Historically, today’s rate of 7.25% is still low. Between April 1971 and April 2024, 30-year fixed-rate mortgages averaged 7.74%. This includes the high of average of 18.63%, to the low of average of 2.96%.

Many people like to point to inflation remaining steady, and the positive employment reports as sufficient reasons for the Fed to drop rates. Easy there hot-rod. This requires some drilling down.

While it is true that inflation appears to be steady-ish, that metric is still well above the declared 2% goal. Early in their rate increase process a big question in my mind was whether the Fed had the grit to withstand external pressure and hold fast until that goal was reached. Evidently, they do, and they will probably need to bump rates up some more to achieve it.

The highly touted jobs report is questionable. As you can see from the chart below, the jobs recovery since the covid lockdowns has mostly been in part-time jobs, not full-time jobs. A critical difference. No matter how you dress it up, a person cannot qualify to buy a house on part-time income. So, before bragging about a “jobs recovery” be sure to ask which jobs are recovering?

In the end, the Federal Reserve was creating so much money out of thin air in 2020 to combat the lockdown effects that they are literally grasping for air on attempts to regain fiscal control of the grotesquely inflated M1 & M2 Money supply. Sadly, they are not even close to being done.

For definition, M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other liquid deposits, and savings deposits (including money market deposit accounts). M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs.

Here is what all that looks like:

See what happened in 2020? See how little those gross inflows have been impacted (relative to the total increases) since the Fed started the stairstep rate increases in 2022 attempting to pull this glut of money out of the markets?

In simplest terms, the M1 money supply increased 360%, while at the the broader money base of M2 grew at a rate of 26.75% from February 2020 to February 2021. One year makes a huge difference. The root of the problem goes back much further, but that’s for another discussion.

Now that you know these rarely discussed facts, it’s easy to see why everything, including home prices, have risen so rapidly and continue to climb. You can also see It’s going to take a very long time to reduce this money glut with only reasonable rate increases. Otherwise, they risk throwing the entire economy into a devastating shock – aka: a severe recession. It’s not just about demand, it’s about cheap and grossly abundant dollars for too long. We can get there, but there is surely more pain between here and there.

With all that said, Benchmark Realty just had the best month since 2021. Why? Consistency in rates and pent-up demand. People can stand high rates; they can stand low rates. What they cannot stand is uncertainty in rates. Quarter point moves are seen as “doable” these days and sooner or later, they’ll get off the bench and into the game.