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The HSH Two-Month Mortgage Rate Forecast

Author: - HSH.com

August 24, 2018

Preface
Although interest rates should probably have been on an modest upward path this summer, driven higher by strengthening growth in the U.S. and inflation returning to (or surpassing) the Fed's desired level, countervailing forces not only capped the minor increase they managed, but also pulled them back down somewhat.

To be sure, this simply kept most mortgage rates fairly level, tethered to ranges at which they began the summer. The reasons are myriad, ranging from all manner of trade and tariff tensions and the uncertain effects on economic growth and inflation both here and abroad; the continuation of stimulative monetary policy programs by major central banks and of late, currency and economic crises in Turkey and Venezuela. Appetites for safe and secure assets by investors remains high, and with a "bull" stock market that is now the longest continuous run in history, some investors may be moving some "wins" out of stocks and into bonds to help lock in gains, and capture yields that are among the highest in years.

The strength of the domestic economy -- GDP running over a 4 percent clip, unemployment claims at 50-year lows, inflation firming to target levels -- all suggest that the Federal Reserve remains on track to raise the federal funds rate by another quarter percentage point in both September and December. Theoretically, rising short-term interest rates should trim economic growth, but stimulative fiscal policy is serving to push output higher even as slightly tighter monetary policy provides a bit of curtailment. News reports have noted that this has put the administration a little at odds with the Fed's policies, but an economy growing at a 4 percent clip really doesn't need help.

As investors adapt to (or at least become more comfortable with the effects of) issues such as those in Turkey and Venezuela, we would expect their effect on yields to diminish somewhat, must as they did after various Greek defaults and bailouts and other such issues. Given this, and with a near-certainty of another lift in the federal funds rate coming next month, it's hard not to expect to see interest rates firming again.

HSH.com 30-yr FRM Forecast Recap Graph

Recap
In our last forecast, we generally expected mortgage rates to remain flat, and that was very much the case. In fact, for 30-year FRMs, the range from high to low over the period was eight basis points, a move of less than one basis point per week on average. For the late June to late August period, we expected 30-yr FRMs to hold between 4.53% and 4.80%, and the market gave us 4.52% to 4.60%, so far more stable than expected and at hugging our lower forecast bound. For hybrid 5/1 ARMs, we thought that a paid of 3.76% and 3.98% fences would contain the average rate for the most popular ARM; a 3.74% low-water mark and 3.93% peak were very much in line with our expectations. Overall, we think we hit the two marks fairly well for the period.

HSH.com 5/1 ARM Forecast Recap Graph

Forecast Discussion
Given the recent period of fair stability, how long can interest rates remain stagnant? In just a few weeks, the lull of summer will give way to the quickening pace of activity of the fall and there is at least some reason to think that interest rates will firm up a bit starting soon.

For starters, investors seem to have largely ignored the long uptick in price pressures that has seen U.S. inflation hit the Fed's desired level for "core" Personal Consumption Expenditures of an annual two percent. Yes, long-term yields did drive to the 3 percent mark on a couple of occasions, but balked at moving above (or even holding for long) those levels; with the underlying economic drumbeat largely unchanged, we are likely to again test and may pass that threshold. Given the trend, its reasonable to think that there remains at least mild upward pressure for inflation for a while yet, and so it's likely that we'll see inflation creep above 2 percent in the coming months. This alone should provide some reason for interest rates to firm.

Wage growth has been mostly muted but does appear to have picked up some this year; average hourly earnings are currently running at a 2.7% annual clip, but there are increasing reports that employers are starting to pay more to attract and retain workers amid very tight labor markets. Rising wages tend to put more money in worker pockets, and it folks have more money to spend, businesses can feel more comfortable pushing prices higher. A bump in wages to start the year helped mortgage rates run up rather sharply, and with unemployment expected to continue to decline, wary investor eyes will be watching for any upturn in compensation.

From the data, it's not yet clear if the third quarter of 2018 will see GDP grow at a faster rate than what we saw during the second. Economic reports so far have been solid but not uniformly strong, so we might not see another 4 percent handle when the first estimates appear (just after this forecast period comes to a close). Even if we don't, any growth running above perhaps 2.6% or so (believed to be the economy's "potential") will continue to eat resources, help create more price pressures and keep the Fed "in play".

Of course, we're not ignoring the rest of the world, which tends to influence U.S. interest rates considerably anymore. Government bond yields around the world remain well below ours, and so the U.S. remains a very attractive opportunity for investors, not only to park funds in times of localized or even widespread stress, but also to actually achieve some return on a highly safe investment. This will continue to be the case, perhaps more so when the Fed again lifts short-term rates. This demand for yield (or safety and security) will tend to counter rising rates, curtailing to some degree any tendency for them to rise.

With the next increase in the federal funds rate, the Fed may change its characterization of the stance of monetary policy from "accommodative" to something more akin to neutral, and there is a good chance that we're move closer to an "inversion" in the yield curve, where long-term rates are lower than are short-term. May economists believe such an occurrence presages a coming recession, but the Fed's own thinking on this is inconclusive, especially since yields around the globe are being manipulated not by pure market forces but by central banks themselves. As such, an inversion may not be a signal of imminent economic slowdown but rather the result of such policies and persistent low inflation rather than restrictive financial conditions.

In this regard, there is one other influence that may come into play for this forecast period. The European Central Bank will be scaling back its QE-style bond purchases to just $15 billion Euros per month starting in October in preparation for the termination of their program at the end of the year. This downshift comes in the middle of this forecast period, and so could have some influence on yields when the change in the pace of bond buying occurs.

Forecast
We do think that over the next nine-week forecast period that rates will tend to be somewhat higher than those for the period just ended. Given that 30-year fixed rates hugged the bottom of our expected range for the summer, we'll adjust the window a little bit, but downward just a touch. That being said, we think that the average offered rate for a conforming 30-year FRM as reported by Freddie Mac will hold a range of 4.45% to 4.72% between now and late October. If you're considering a hybrid 5/1 ARM, please know that the Fed is again likely to boost short-term rates during the forecast period, and this will tend to add a little firmness to initial interest rates. As such, we think that you'll likely find conforming offers averaging between 3.78% and 4.06% between now and the week before Halloween.

To follow rate movements and their influences on a more frequent basis, check out or subscribe to our weekly MarketTrends newsletter.

As noted above, this forecast expires just before Halloween, and we'll be a full month into autumn at that time. In between football timeouts and fall yardwork, why not drop back and see if we scored a touchdown or fumbled with this forecast?

See previous forecasts

UPDATE

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