Will Mortgage Rates Begin to Slow Their Rocket Ride?

In recent weeks, the U.S. economic landscape has been a hotbed of significant developments that have and will continue to impact the real estate market and mortgage rates. Amidst this dynamic landscape, a complex paradox has emerged – a thriving real estate market with rising prices against a backdrop of banking sector turbulence and evolving Federal Reserve policies.

The increasing mortgage rates have been a focal point of recent concern. The average 30 year fixed mortgage rate reached a high of 7.14% under the pressure of impending Federal Reserve rate hikes, troubles in the regional banking sector, and the contentious debate over raising the U.S. debt ceiling. However, after a period of intense negotiations, President Biden and Speaker of the House Kevin McCarthy managed to agree to raise the debt ceiling, preventing a potential U.S. default and potential global economic calamity, leading to a slight drop in rates to 6.88%.

Compounding this, Federal Reserve officials have hinted at a shift in policy, raising hopes for potential buyers. Fed Governor Philip Jefferson and Philadelphia Fed President Patrick Harker suggested that the Federal Reserve might pause interest rate hikes at the next meeting in June to assess the economic implications of previous increases. However, this news also came with a caveat; the central bank could resume rate hikes later in the year if inflation fails to abate. The remarks from Jefferson were particularly significant, as President Biden recently nominated him to be the Vice Chairman of the Federal Reserve Board.

Fed Chair Jerome Powell had hinted earlier in May that “We face uncertainty about the lagged effects of our tightening so far," adding “the risks of doing too much versus doing too little are becoming more balanced.”

However, the president of the Federal Reserve Bank of Dallas, Lorie Logan, wrote "The data in coming weeks could yet show that it is appropriate to skip a meeting... As of today, though, we aren’t there yet.”

Still, market watchers seem to be following Jefferson and Harker's leads, with the latest data showing that traders are pricing in a 65% chance of no rate hike on June 14.

The banking sector has had its share of upheavals too, with significant regional bank failures. Silicon Valley Bank, Signature Bank, and First Republic Bank—overexposed to long-term bonds bought at low interest rates prior to the Fed's rate hikes—were among those that collapsed. Some were also overexposed to the volatile cryptocurrency market, adding to their financial woes.

Despite these financial uncertainties, the real estate market has shown extraordinary resilience. Contrary to expectations, home prices have continued to ascend from their lows last November, a trend particularly noticeable in the Northeast region.

An exacerbating factor is the continued inventory crisis. Many markets are still grappling with supply shortages, with inventory levels below 2.5 months supply at current rates of absorption. This lack of supply has heightened competition among prospective buyers, leading to fierce bidding wars even for homes in need of significant renovation.

The recent spate of Federal Reserve hikes have come under heavy scrutiny, with critics arguing that the increased rates are exerting further pressure on the beleaguered banks, especially considering that their stock of long term low interest bonds are devalued even more after each Fed Funds Rate hike. The aftermath of the last hike saw a dramatic drop in regional bank stocks like PacWest and Western Alliance, sparking concerns about the viability of these institutions. The National Association of Realtors' chief economist, Lawrence Yun, joined the chorus of critics, branding the hikes "unnecessary and harmful."

The recent agreement to raise the U.S. debt ceiling has brought some much-needed stability in these volatile times. The agreement has averted a potential U.S. default on its debt obligations, particularly Treasury bills and has helped stabilize mortgage rates to some extent. A collapse of the 10 year Treasury would have spelled disaster for the mortgage industry, which essentially ties 30 year fixed mortgage rates to the 10 year.

Looking ahead, the prospect of a pause on rate hikes in June, as suggested by leading Fed officials, offers some hope for potential buyers grappling with high mortgage rates. However, it's important for buyers to remember that this possible pause doesn't mark the peak rate for this cycle. If inflation shows no signs of declining, the Federal Reserve is prepared to return to rate hikes in the coming meetings.

In conclusion, the resilience of the real estate market amidst economic uncertainty is noteworthy. Despite potential disruptions from the banking sector and possible policy shifts by the Federal Reserve, the real estate market continues to thrive, bolstered by continued demand and a chronic inventory shortage. However, buyers and sellers must maintain vigilance in these complex times, keeping abreast of economic developments, policy shifts, and their potential impact on the real estate market.