We research, you save.

The HSH Two-Month Mortgage Rate Forecast

Author: - HSH.com

August 28, 2015


Although global financial markets have teetered of late, all indications are that the U.S. economy remains heading in a positive direction. To be sure, China's attempts to stabilize its stock markets didn't work, and the most recent attempts to stimulate growth by chopping interest rates and devaluing the Yuan may or may not produce the kind of growth desired there.

China's effect on other economies, especially those that supply commodities and raw materials are most at risk for slowdown, and to the extent that this affects our own export markets we have will encounter some domestic risk as well. Perhaps more difficult to overcome than the wobbly financial markets is the global currency devaluation that has put dollar-denominated goods at a pricing disadvantage, tempering our economy's ability to grow at a faster pace. However, as we are a net consuming nation, lower cost goods and oil have generally positive effects here, especially if wages remain fairly stagnant despite solid labor markets.

Into this (and amid myriad other issues) comes the Federal Reserve. Almost all signals suggest the economy has moved well past the need for emergency-level interest rates, even if it has become difficult to foster the kind of inflation the Fed hopes to see. A small upward move in interest rates would really have very little effect on interest cost or change the inflation picture to any degree, but it would put some additional stress on exports. That said, it would be a powerful signal that the Fed believes that the U.S. economy is actually in a recovery in more than name only.

If the "damage" from a small rate rise is likely to be minimal, if not non-existent, the question may be: What are we afraid of?

While we're generally pleased with the outcome of the last forecast, the pattern we expected to see didn't materialize, thanks in part to the late August financial market upheaval. It's difficult to foresee such events, which come with few advance warnings; in some cases, these events come and go very quickly (i.e. the so-called "flash crash"), or can come quickly and leave somewhat more slowly, which seems to be the case this time. In either case, markets can be left roughly in the same place in which they started, if somewhat bruised from the process.

HSH.com FRMI Recap Graph

For the last go-round, we expected HSH's Fixed Rate Mortgage Indicator (FRMI) to hold a range of 3.97 percent to 4.25 percent; the markets presented us with a 3.94 percent to 4.15 percent pairing. Also, we expected that the FRMI's Hybrid 5/1 ARM companion would run into borders of 2.95 percent and 3.20 percent over the last nine-week period; we encountered a much tighter 2.95 percent to 3.09 percent set. In our last forward-looking missive, we believed that the conforming 30-year FRM would be fenced in on the low end at 3.95 percent, and on the high side at 4.30 percent, and we remained between those points with a 3.96 percent bottom and a 4.14 percent top. All in all, a fairly accurate forecast, even though there was less movement than expected during the period.

HSH.com 5/1 ARM Recap Graph

Forecast Discussion
So what are we afraid of with regard to higher short-term rates... or more importantly, what is the Fed afraid of?

To start, we'll get it out of the way: From our perspective, the Fed should lift rates a quarter-percentage point in September. Should they hold, we think the Fed risks a loss of credibility of sorts, as a continued lack of action on their part continues to signal a lack of confidence in the durability of the U.S. economic expansion. If a 5.3 percent employment rate, an economy producing about 2 million jobs per year, a 2+ percent annual growth rate over the last few years and signs of considerably improved consumer spending aren't the right set of conditions to lift rates off record-low bottoms, then what are the conditions that will make it so?

Will the consumer be affected by slightly higher rates? Barely so, given that much consumer debt (and especially that accumulated during the recovery) is fixed rate. Yes, some home equity line of credit and credit cards costs may rise a tad, as might business lines of credit and such, but those effects are minimal. There are considerably far fewer adjustable-rate mortgage resets to worry about now than perhaps at any time in the last generation... and the few newer ARMs that have been originated mostly won't see any change for years yet. The Fed isn't directly manipulating long-term mortgage or other interest rates any longer, and short-term interest rates and long-term mortgage rates have little direct relationship with one another, regardless. Odds favor that the funds flowing into longer-term Treasuries (often the result of poor economic situations elsewhere) will persist, keeping fixed-rate mortgages low (not at record lows, though) for some while yet, and so the housing market shouldn't be much impacted. As such, this shouldn't give either the Fed or a consumer pause with regards to a rate change.

Will inflation be trimmed a bit by higher interest rates, which will tend to further strengthen the dollar? Yes, a little. However, below-zero "real" interest rates and outsized stimulus may have prevented outright deflation over the last few years, but there isn't any evidence that it has been successful in creating inflation, either. On a practical basis, exports would be impacted a bit more, but no more than say, the collective devaluation of the currencies of major trading partners... and this may keep them from devaluing further, putting more control in the hands of the Fed than not. Of course, as a net importer of goods, lower inbound prices for goods and oil aren't necessarily a bad thing, in light of a consumer whose incomes have been more stagnant than not in recent years. The fact is, there's nothing special about attaining the 2 percent inflation the Fed might like to see, and 1 percent would probably do just as well, provided it can be expected to remain reasonably constant over time.

We don't think there's much downside to a small change in rates, and there are likely to be positive signals. Asset markets (stocks, homes) have all been reflated at a fairly rapid pace over most especially the last couple of years, and a slowing of appreciation as we go is probably healthier in the long run. The process of reflating retirement assets and home values could continue, albeit at a slower pace, but not everyone in the world owns equities or a home... and some who might like to cannot easily catch up with prices rising at the current rate.

Is the Fed concerned about upsetting financial markets further, particularly given the recent episode? Possibly. To be fair, though, markets have been volatile on more than a few occasions during the course of the recovery and expansion, most notably from bad news about a given economy or situation than from a good one. A small positive signal -- especially if accompanied with repeated soothing messages about the future path of policy -- should not disrupt the markets anywhere any more than we've already seen in recent years... and we have recovered and moved on from those events.

Although the whole of this forecast isn't truly about the Fed, the September Fed meeting is the dominating event of the forecast period. We think the Fed should make the move, say soothing words about where we're going and how fast change may come, see how their new tools and processes work, let the dust settle... and check back in long about next February to see if another move might be appropriate.

Given the events of the last week or so in the financial markets, it seems wrong to say that we expect an unsettled or volatile period for mortgage rates during the forecast period. Despite all the bouncing about for equities and bonds, mortgage rates barely moved.

Determining the effect that the upheaval in global markets has had on the Fed's thinking is hard to know. At least one Fed governor said that a September move felt "less compelling" now than it did weeks ago. An less-united or even undecided Fed would tend to inject volatility into rates, for better or worse.

If the Fed punts at the September meeting, we might see some downside for rates, but not much. The economic momentum of the second quarter seems likely to have at least mostly spilled over into the third, and that's been a key factor in keeping rates from backing down in recent months. This is likely to continue to be the case over the next nine weeks.

With the possibility (but probably not a likelihood) of some downside for rates, we've adjusted our last set of ranges a bit. Between now and the end of the forecast period, we think that HSH's FRMI won't break below perhaps 3.90 percent, and won't get much above 4.27 percent. The FRMI's 5/1 Hybrid ARM companion would be more affected if the Fed should move short-term rates, but we think that a range of 2.92 percent to 3.22 percent will provide containment. Conforming, 30-year fixed-rate mortgages should hold in a 3.88 percent to 4.25 percent range until this forecast expires on October 23rd.

At that point, we'll have long passed the September Fed meeting and seen the FOMC's thinking revealed in the minutes, change to policy or not... and be right on top of the October meeting, too. Regardless of whether you think the Fed should move or not (or is right or wrong in why they have or have not), why not check back to see if our crystal ball has worked with regard to mortgage rates?

See previous forecasts


Read the latest HSH Market Trends - and get it via email on Friday.

Buy Our Mortgage Survey
 Mortgage Glossary  Mortgage Quick Search

One form, up to 5 competing quotes