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Economists who put together two of the real estate industry’s most closely watched forecasts agree that mortgage rates have probably peaked, but are sharply divided on how quickly they’ll come down over the next two years.
Economists at Fannie Mae are taking Federal Reserve policymakers at their word that they intend to pursue a “higher for longer” rate strategy, which would keep mortgage rates above 7 percent next year.
But forecasters at the Mortgage Bankers Association expect mortgage rates in the mid-6 percent range by the end of next year and in the mid-5s by the end of 2025.
Mortgage rate forecasts sharply diverge
Source: Fannie Mae and MBA forecasts, November 2023.
“Our baseline expectation is that the Fed will not raise rates further this cycle but will keep policy tight until it is clear that inflationary pressures have abated,” forecasters with Fannie Mae’s Economic and Strategic Research (ESR) Group said in commentary accompanying their Nov. 21 housing forecast.
Mortgage rates registered their biggest one-day drop in nearly four years on Nov. 14 after the Bureau of Labor Statistics reported that the all-items Consumer Price Index (CPI) fell to 3.2 percent in October, down from 3.7 percent in September.
While acknowledging that “recent volatility at the long end of the yield curve” adds “additional risk” to their forecast, Fannie Mae economists are now less optimistic about the prospect of lower rates than they were in October.
In their October forecast, Fannie Mae’s ESR Group predicted rates on 30-year fixed-rate mortgages would fall to an average of 6.7 percent during the fourth quarter of 2024. In their latest forecast, which extends into 2025, Fannie Mae economists predict rates will average 7.1 percent in Q4 2024, and only drop below 7 percent in Q2 2025.
In their Nov. 17 mortgage finance forecast, MBA economists said they see rates descending more sharply, to 6.1 percent by Q4 2024 and 5.5 percent by Q4 2025 — a difference of more than 1.3 percentage points.
“The Fed’s hiking cycle is likely nearing an end, but while Fed officials have indicated that additional rate hikes might not be needed, rate cuts may not come as soon or proceed as rapidly as previously expected,” MBA Chief Economist Mike Fratantoni said in presenting the trade group’s 2024 outlook.
But MBA forecasters still see room for mortgage rates to fall dramatically if the unusually wide spread between Treasury yields and mortgage rates narrows. That’s also the view of Lawrence Yun, chief economist for the National Association of Realtors, who thinks rates on 30-year fixed-rate mortgages could fall to between 6 and 7 percent by early spring.
The “30-10 spread” — the difference between rates on 30-year fixed rate mortgages and 10-year Treasurys — has been as high as 3 percentage points this year, about twice the historical average.
If the spread were back to normal, mortgage rates would be around 6.1 percent to 6.6 percent today, even without Fed easing, Yun noted in Nov. 14 presentation at NAR’s NXT Conference in Anaheim.
One factor behind the wide 30-10 spread is the elevated prepayment risk currently faced by investors who buy mortgage-backed securities that fund most home loans. Homeowners who take out mortgages at today’s relatively high rates are likely to refinance them if mortgage rates come down. But prepayment risk could diminish once rates start to come down, reducing the 30-10 spread, according to an analysis by the Urban Institute’s Laurie Goodman and Michael Neal.
“While rates have been volatile, with markets weighing a stew of changing inflation expectations, heightened Treasury issuance and fiscal deficits, and global growth outlooks, the sharp drop in yields following soft October inflation print is noteworthy,” Fannie Mae forecasters acknowledged. “It suggests once bond markets are convinced that inflation is contained, either via a soft landing or the start of a recession, that mortgage rates will have some room to recede, especially if the currently wide spread to the 10-year Treasury rate tightens after near-term worries of higher long-run Treasury yields soften.”
While inflation has defied many forecasters’ expectations and made it difficult to predict where mortgage rates might be headed next, MBA and Fannie Mae economists agree that the U.S. is probably headed for a mild recession next year.
The MBA’s Nov. 17 economic forecast projects real gross domestic product (GDP) will hit -0.4 percent in Q1 2024 and -0.5 percent in Q2 before rebounding to 0.9 percent in Q3. Two consecutive quarters of falling GDP is a widely used benchmark for a recession.
Fannie Mae economists see a recession hitting a little later and a little harder, with GDP falling to -1.5 percent in Q2 and -.5 percent in Q3 before rebounding to 0.5 percent in the final quarter of the year.
“While the combination of ongoing employment gains and decelerating inflation has increased the likelihood of a soft landing, the ESR group contends that, between a likely slowdown in consumption growth stemming from an imbalance between spending and incomes and the rising real federal funds rate weighing on consumer and business activity, a downturn remains the most likely outcome,” Fannie Mae said in announcing its latest forecast.
Projected sales of existing homes
Source: Fannie Mae and MBA forecasts, November 2023.
Fannie Mae economists expect sales of existing homes to decline to a seasonally adjusted annual rate of 3.9 million homes during the fourth quarter, the lowest pace of sales since 2010, and not bottom until Q1 2024.
“We have revised our forecast modestly downward largely due to the higher projected interest rate environment,” Fannie Mae forecasters noted. “Again, however, the heightened volatility of long-run interest rates in recent weeks points to risk around the sales projection.”
MBA forecasters think sales of existing homes bottomed in Q3 2023 and are poised for eight consecutive quarters of growth after adjusting for seasonal factors.
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