Sometimes you have to take some bad news with some good news. The good news is that the U.S. economy is showing signs of improving and that may help an anemic housing sector recover. The bad news is that all of this good news exerts upward pressure on mortgage rates, which, in turn, could inhibit future refinancing and home purchase activity.
An improving economy has exerted upward pressure on long term Treasury yields as the credit markets slowly approach normalcy. Over the past two months, the 10-year Treasury bond has risen by almost 70 basis points. Ten-year Treasury yields are currently hovering around 3.18 percent (as of this writing), compared to 2.5 percent just two months ago.
With the economy and financial markets in peril and disarray just a few months ago, investors sought a safe haven for their funds in U.S. Treasury bonds and notes. But as the economy and financial markets continue to improve investors have become more willing to take on greater risk. More funds are flowing into the equities market and commercial bonds than in previous quarters. Credit spreads have narrowed as investors become more comfortable with today’s market conditions.
Although mortgage rates have not yet begun their ascent, it is only a matter of time. We need to accept the notion that as the economy and housing sector recovers; mortgage rates are likely to rise. That is a trade-off worth taking.
For the last several months, the Federal Reserve has been purchasing Treasury bonds and mortgage-related securities in an effort to bring mortgage rates below 5 percent. According to Freddie Mac’s latest weekly rate survey, 30-year mortgage rates were 4.84 percent, close to a historic low. The central bank’s bond purchase program was successful and now it may be time to slowly wind it down.
Fortunately, falling mortgage rates have resulted in a burst of refinancing applications. The Mortgage Bankers Association’s (MBA) refinance index jumped a whopping 45 percent to 6,540 in mid-April from a low of 4,497 in mid-March when the Federal Reserve began its bond purchase program. Since mid-April, mortgage rates have drifted slightly upward, lowering the refi index to 5,169 as of the latest week. This downward trend is likely to continue should mortgage rates rise further.
On the other side of the mortgage coin, falling mortgage rates have not inspired households to apply for loans to purchase homes. The MBA’s purchase index has hovered around 260 during the past two months. Mounting job losses, reduced household wealth, low consumer confidence, tight mortgage credit and falling home values continue to more than offset the positive impact of lower borrowing costs. However, an improving economy is likely to have a positive influence on the very factors keeping households from purchasing homes. We expect the pace of job losses and falling home values to slow, consumer confidence to improve, and mortgage credit to loosen a bit as the economy begins to rebound. Ironically, rising mortgage rates may be a sign of health and progress for the housing market rather than be an impediment to the buying and selling of homes.