June 14, 2024
Preface
Investors began 2024 with a fairly strong conviction that the Fed would likely be cutting rates all year. This faded quickly when inflation became less well behaved, and for a time, financial markets acted as though rate increases might have become a more likely outcome. Of late, though, these feelings seem to have become more ambiguous; at least according to futures markets, prospects for at least one or perhaps two rate cuts remain in play for 2024, and this became the "official" outlook with the release of the June Summary of Economic Projections from Fed members.
Mortgage rates have reflected this, with 30-year FRMs running down to as low as an average 6.6% in January, then climbing back to 7.22% by early May. Now, as signs of some economic slowing have appeared and inflation pressures seems to have at least leveled off, mortgage rates have begun easing slightly again, or at least retreating somewhat further from May's 2024 peak.
If inflation is really again cooling, this should allow long-term interest rates and fixed mortgage rates to decline, at least a bit. Realistically, there is only so far they can fall until the Fed more explicitly signals that rate cuts are coming, if not actually making a change to lower the federal funds rate. In turn, this would help lower the interest rate floor for the entire yield curve. But will this come, and if so, when?
The Fed is navigating through some cross-currents at the moment. The economy has slowed up somewhat, labor markets are somewhat looser, and inflation appears to be flattening again. While the current level of monetary policy is said to be "restrictive", it's by no means clear if it is restrictive enough to achieve the Fed's goals. Presently, is the current collective level of growth, employment and inflation at a level sufficient for the central bank to signal cuts in rates? Probably not, or at least not anytime very soon.
While a hopeful sign of inflation again retreating came with the May CPI report, much more will be needed to convince the Fed that it's time to start trimming rates. It seems to us that this summer will be one of a waiting game -- waiting for data, waiting for signals from the Fed, and waiting for mortgage rates to start what may be a long journey back toward "normal", wherever that may now be.
Recap
When last we pulled out the crystal ball back in early April, we thought that mortgage rates would have a touch of firmness during the forthcoming nine-week period. At that time, we forecast that the average offered rate for a conforming 30-year FRM as reported by Freddie Mac would run in a range of 6.74% to 7.14%, and the markets presented us with a 6.88% and 7.22% pair of stops. We'll call the last forecast "pretty good", as only two of what turned out to be a ten-week period were outside of our expected boundaries.
Rates for 5/1 ARMs were a bit of a different case. We expected that they would hold in a bit of a lower range during the April-June forecast period, running in a 6.09% to 6.49% range over the ten-week period. Instead, they never got any lower than 6.37% but no higher than 6.64%, and so spent most of the last forecast period rather above our expected range. Not terribly so, but enough to only see four of 10 weeks meet our expectations. The changing outlook for short-term interest rates played a role here, but it's also true that ARMs aren't exactly a favored product at the moment (by lenders or borrowers), so lenders aren't pricing them especially aggressively, either.
Forecast Discussion
The summer's often a sluggish time for financial markets. Warm weather, long days, short weeks and vacations all tend to add some dullness to the level of activity. That's probably going to again be the case this year, but perhaps with a bit of an edge, as investors will likely keep an ear turned toward inflation reports as they come. May's CPI report -- just out as we write this -- provided some comfort, as inflation came in just slightly below expectations. This helped long-term interest rates to retreat a little bit, at least in the initial reaction, but even a step in the right direction for inflation is still only one step; the Fed will want to see at least some more (perhaps many) before it decides to make any move. At 3.4%, core CPI is now at its lowest levels in three years, but it is also still well above the Fed's goal.
What would it take to downshift fixed mortgage rates more meaningfully, returning them to 2024 lows (6.6%) if not actually push them lower than that? To be sure, it's going to take more than just one or two improved inflation readings. The Fed's preferred inflation measure is released with a full month's lag, and so we'll not see PCE inflation data for May for several weeks yet. After that, June's report comes just days before the July Fed meeting, rather late for members to consider a policy change even if it shows inflation is continuing to improve at that time. That said, July's PCE report comes weeks ahead of the September meeting, and if there actually is a string of three or four months of softening price pressures by then, a September rate cut becomes a real possibility. Essentially, everything needs to go right in order to make this a reality, and as we've seen all too frequently, most of the time very little goes according to plan.
To get to a place where the Fed will consider cutting rates, the very resilient economy will need to throttle back to a below-potential pace, and not just for an occasional quarter or two. Labor conditions -- looser now than they have been, but not nearly loose enough as yet -- will need to continue to show signs of more slack. Still-sticky service costs need to settle to a greater degree than they have to date. Goods inflation needs to continue to retreat or at least fail to pick up again. More importantly, even if these beneficial happenstances and trends should show, investors and the Fed both need to be convinced that the path ahead will continue to see routine progress towards the Fed's inflation goal, and that as a result, a downcycle for Fed rate policy will be the likely path going forward into 2025 and perhaps beyond.
Give the recent experience of fits and starts for these economic trends -- periods of economic slowness that have given way to faster growth, slowing inflation that gave way to at least a few-month firming pattern, a stall in job creation that lasted only a brief period -- we're at least a bit skeptical that the path ahead will be both favorable and smooth, as experience suggests otherwise. Given the sensitivity interest rates have shown to data pointing to a strengthening economy or more inflationary climate, there remains a real risk that interest rates could flare upward, too, as they did in April and May.
We're not pessimistic regarding the prospects for lower interest rates and lower mortgage rates, but average rates for 30-year fixed-rate mortgages still seem unlikely to break below 2024 bottoms anytime very soon, or at least during this particular forecast period. That's not to say that they cannot be lower than they are now, but that they probably aren't likely to be very different than those we've already seen so far this year.
Mortgage rates can't turn meaningfully lower until more data suggests that the kind of inflation trend the Fed wants to see is falling into place. As those reports generally come no more frequently than once per month, as we can do is wait for the passage of time to help fill in the picture. So, we wait.
Forecast
The prospects for somewhat lower rates during this forecast period compared to the last one are pretty good, but the key word here is "somewhat". If things do go 100% right in terms of inflation, labor conditions and economic activity between now and mid-August when this forecast expires, there's a very reasonable chance that measurably lower interest rates and mortgage rates will be in the offing come fall.
More likely is that the trends that need to be favorable are mostly but not wholly so, and mortgage rates settle a bit and then wander about as the summer doldrums kick in.
If lower rates are in the offing for the fall, well, that's a subject we'll of course be evaluating and considering in the next Two-Month Forecast.
For this one, over the next nine-week period, we think that the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac will manage to hold in a range of 6.66% to 7.08%, tending to hold toward the bottom of the range when news is favorable and the top when it is not.
For the initial fixed interest rate for a hybrid 5/1 ARM, which has been having trouble getting close to the bottom of our expected range of late, we think that this product should wander between a pair of 6.28% and 6.68% fences between now and mid-August. Whether such a small rate differential between this and the expected rate for 30-year FRMs is sufficient to attract any potential homebuyers is uncertain, but in today's costly housing and mortgage market, every nickel counts.
This forecast expires on August 15, 2024, when summer will be starting its downward run to a close. By that time, we'll have gotten past the July Fed meeting and should have a realistic expectation as to whether or not rate cuts by the Fed will come this year. Before you head out on that last-minute vacation or staycation, drop back in and see how we fared with our summer prognostication.
Between now and then, interim forecast updates and market commentary can be seen in our weekly MarketTrends newsletter. You can sign up to get MarketTrends by email, too.