Where are mortgage rates headed?

As interest rates continue to climb and approach last year's high of 7.37%, currently sitting 7.34% as of 8/16 according to Mortgage News Daily, let's evaluate where interest rates might be headed from both a high and low perspective. Bill McBride of CalculatedRisk does a deep dive into the "New Normal" for interest rates which is a fantastic read and I highly recommend it as it's where I derived several data points.?

Let’s first analyze rates in the short term. Currently the US10Y is ranging near last year's October / November high. The number to break is 4.250%. The closing candle on 8/16 officially broke above the high of 4.250% and now we wait for Thursday and Friday to see if continued momentum will bring the 10Y higher. I do believe follow through is needed here as this is a very tough range to break. With each new bullish economic indicator that comes out the likelihood of higher interest rates increases.

If we want to look at rates in the long term, we need to analyze the possibility of the 4.25% range breaking up and if it does, where does that mean rates are headed? If you see the chart below the zones highlighted on the upside are roughly 4.50% and 5.25% and then 3.25% on the downside. (I am rounding these to the nearest 1/8th for simplification purposes). The 4.5% and 5.25% range on the 10Y are long term resistance zones / pivot points from 2007 and 2008.?

As the US10Y and 30-year fixed mortgage rates have closely followed one another for 50+ years, we can use this to help estimate where rates might be heading. As we've discussed in the past, the normal spread between US10Y and 30-year fixed mortgage rates is around 175 to 200 BPs. Since October of last year, the range has been 250 BPs to 320 BPs and essentially the last 6 months has averaged near or above a 300 BPs spread.?

Why is the spread so much higher than historical standards and why is it likely this spread will continue for the near future? As interest rates are above 20+ year highs (with the exception of 1 day in October 2022) we know that every homeowner will be looking to refinance into a lower rate should interest rates fall. As there is no borrower prepayment penalty to refinance your house as quickly as possible, the potential for quick payoffs increases volatility thus increasing the spread. In conclusion if the spread remains at 300 BPs which it appears it will until the risk of volatility decreases, we can measure future possible interest rate ranges.

Low end 3.25% 10YR + 300 BPs = 6.25%

Current Range 4.25% 10YR + 300 BPs = 7.25%

Next level up 4.50% 10YR + 300 BPs = 7.50%

Highest level up 5.25% 10YR + 300 BPs = 8.25%

Now obviously these are only ranges and this is only meant to give us a possible indication of where rates may be headed using current and previous data to estimate. We could of course go higher or lower, but these would be my ranges for the foreseeable future (next 2-4 quarters).

Now the question always remains, when will interest rates go lower? It's interesting, you always hear that the Fed Funds rate doesn't directly affect mortgage interest rates which yes technically is true however, the correlation between them is evident. The chart below highlights the US10Y, the Fed Funds rate and 30-year fixed interest rates.?

We can see the spread between the US10Y and the Fed Funds rate usually ranges from 0 to 2.

Why is this important? Well according to the CME futures, even after continuous bullish economic data the futures swap index is showing an 88.5% likelihood that our current 5.50% benchmark rate is the top in this rate hike cycle. Should this be the case and if the below projections come to fruition the Fed would be scheduled to start cutting rates in Q2 of 2024. As we can see from above mentioned charts, using the correlation between the Fed Funds rate > US10Y > 30 Year Fixed Interest rates this would have the potential to bring mortgage interest rates lower.

We'll have to continue to watch all the economic data points to see if this CME futures index will be proven true. GDP in Q3 appears to be more bullish than originally indicated, jobless claims remain low, and according to today's Fed meeting minutes Fed officials expressed concern at their most recent meeting about the pace of inflation thus increasing the possibility of future rate hikes.