Fed could start to cut, but mortgage rates play by their own rules

For now at least, these two forces may be ready to pull in somewhat opposite directions. That could help keep mortgage rates relatively stable: Average 30-year fixed mortgage rates changed little from the start to the end of the third quarter, at around 3%, according to Freddie Mac’s weekly survey. Fannie Mae economists currently predict that rates will stay at about the same level by the end of the year and hit just over 3% next year.

A threatening factor to push mortgage rates up is that yields on mortgage-backed bonds issued by government-funded firms such as Fannie and Freddie have been unusually close to Treasury yields. Many analysts attribute this in large part to the Fed’s purchase of mortgage bonds, which the central bank started making in large volumes last year as part of a series of measures to support anxious markets. in the depths of the pandemic. This means it is possible for the spread to normalize, pushing mortgage bond yields up even faster than Treasury yields. This in turn would put upward pressure on mortgage rates as mortgages are sold in these vehicles.

But there is a counterweight. Mortgage lenders could absorb some of this pressure without passing it all on to borrowers in the form of higher rates. During much of the pandemic, mortgage originators have been very profitable, earning unusually high margins on the sale of Fannie or Freddie-eligible mortgages in the bond market. One indicator of this is the spread between fixed 30-year mortgage rates and the yield on mortgage-backed securities.

This spread widened significantly in 2020 as homeowners rushed to take advantage of low rates to refinance. The rush in demand meant that lenders were leveraging prices. It takes time for originators to hire enough people to cover demand, which limits the supply of mortgages.

As rates rise and the pool of people eligible to refinance their mortgages shrinks, that capacity becomes excess – a rollback process takes time. The gap narrowed over the course of this year, but it is still higher than it often was in the two years leading up to the pandemic.

“At least for the next few quarters, much of the impact of tapering is likely to be felt more by lenders than borrowers,” said Bose George, analyst at KBW.

Not only that, but the recent emergence of large publicly traded initiators like Rocket Cos., UWM Holdings, and LoanDepot have provided the diversification and scale needed to reduce marketing, technology, and other lending costs. Even faced with tighter spreads, companies may continue to struggle for volume and market share. Mr. George says that during times of intense competition, spreads can fall well below average, which KBW expects to happen in 2022.

There is also reason to believe that mortgage bond yields may continue to trade relatively close to Treasury yields after widening slightly recently. In addition to the Fed, the deposit-drenched banks were big buyers of mortgage bonds. Of the more than $ 8 trillion in agency mortgage bonds in circulation, about $ 6 trillion is “stranded” with the Fed and banks, notes Satish Mansukhani, mortgage-backed securities strategist at Bank of America.

“The outlook is relatively stable,” he says. “Even with the Fed retreating, it will take time for the market to take this into account.”

Even as mortgage rates rise, there are other ways to keep home buying and refinancing relatively affordable and to keep up the volumes for originators. Government sponsored companies such as Fannie or Freddie could help. Part of what determines at what price an originator can sell a mortgage, and related, what rate to charge, is what it costs to secure the debt with the GSEs. GSEs are already ending pandemic fees intended to compensate for a higher risk. The Biden administration may also be looking for other ways to lower fees or other barriers for some borrowers to promote housing affordability.

A wild card: if house prices continue to soar, fueled in part by low rates. This could be a factor influencing the Fed’s thinking on how aggressive it should react to rising asset prices. High prices could induce an increase in housing supply, but if not, and if the Fed’s cut turns into a sale of bonds, or if interest rates start to rise significantly sooner, something simple is likely to happen to mortgage rates: they will go up.

Write to Telis demos at [email protected]

Corrections and amplifications
Bose George is an analyst at KBW. An earlier version of this article mistakenly referred to him as Mr. Bose in the second reference. (Corrected October 8)