Mortgage rates aren’t sending signal homebuyers need on affordability

Lawrence Yun has as big a stake in the Federal Reserve’s moves as any economist: As the chief economist for the National Association of Realtors, his industry is a target of the Federal Reserve’s efforts to tame inflation with higher interest rates.

But the housing’s industry’s bigger problem right now may be the bond market, and specifically, spreads between treasuries and mortgage rates that suggests homebuyers’ economic challenges may not decline even as the Federal Reserve is nearing the end of its interest-rate hikes. There is a historically-wide difference between the 10-year treasury bond, a benchmark for pricing mortgages, and the actual price of an average 30-year loan. Usually around 1.75 percentage points, and as low as 1.3 in 2021, the so-called mortgage spread is hovering at more than 3 percentage points now. And that is propping up mortgage rates, keeping home owners from selling their homes and buying nicer ones, and hurting first-time buyers, Yun said.

“Buyers know 3.5% mortgages aren’t coming back,” Yun said. “So 5.5% would bring out buyers.” 

Why mortgage spreads should move lower

Logically, mortgage spreads should move down sharply from here, thanks to the recent spate of good economic news, and bring relief to home buyers who have seen affordability deteriorate sharply since 2020. 

Traditionally, spreads widen when markets fear a recession. They spiked before the financial crisis of 2008, for example. Collapsing spreads help revive housing activity after a recession arrives, or can prop up the housing market in a crisis, which happened in 2021 as the Covid pandemic threatened an economic crash. But as the Fed began raising interest rates in March 2022, mortgage rates rose even faster than bond yields.

The case for wide spreads this past year was two-fold. Partly, it was rooted in the idea that the 10-year treasury yield would rise as the Fed hiked more. Fear of a 2023 recession also contributed — evidenced by a sharp widening of spreads in March, after Silicon Valley Bank failed.

Now, both cases are evaporating. Last week’s inflation report showed consumer prices rose just less than 3% for the 12 months ending in June, down from more than 9% a year earlier. Low inflation should persist into the fall, because the government’s measure of housing inflation lags private market data that has been moving lower since last summer. The consumer price index is expected to only start to reflect the now year-old dip in rents and home prices in parts of the U.S. by year-end.

At the same time, the Atlanta Federal Reserve Bank’s tracking estimate of second-quarter economic growth now sits at 2.3% belying predictions of an early-2023 recession that were widespread.

The recent inflation news pushed the 10-year treasury lower, touching 3.76% after reaching 4.09% earlier in July. Mortgage rates…