August 16, 2024
Preface
In just a few weeks' time, the Federal Reserve will likely start what may be a lengthy process of lowering interest rates. If they should cut rates in September as is widely expected, it will be the first reduction in short-term rates in more than four years, when the pandemic prompted a series of emergency moves by the central bank.
Investor positioning in anticipation of the coming cut coupled with economic data that temporarily prompted a "growth scare" and the turbulent unwinding of some currency "carry trade" positions by investors saw interest rates slump hard in early August. Since then, the fundamental economic data has been pretty solid and soothing, and as a result, at least a portion of the unexpected and significant decline in rates is being erased as we develop this forecast.
With the coming cuts in rates widely expected and markets already positioned for such, it is the longer-range outlook that will dictate what happens to interest rates and mortgage rates as we look forward. The next Fed meeting features an updated Summary of Economic Projections. Essentially, these are Fed member forecasts for the potential direction of monetary policy over the coming months and beyond, and this outlook will help drive mortgage rates into the end of the year and into next.
It is certain that we'll have lower mortgage rates in place this fall, at least compared to those seen in the spring, and possibly even lower than August's brief 15-month lows. What's less clear is how much lower, something that depends on whether or if inflation continues to decline during the coming months, and whether the economy can keep on growing at a measured pace or not.
If nothing else, the spate of considerable financial market volatility in early August may have left investors in a more sensitive, twitchy state. It feels as though there has been a shift from earlier this year, where positive economic news and somewhat firmer inflation data prompted upside volatility in mortgage and other interest rates; now, signals that the economy or labor markets are faltering (or inflation more quickly cooling) may result in downward volatility in interest rates.
Financial markets didn't seem to experience the typical summer doldrums of sluggish activity this year, so there was no period of rest and reflection before the quickening pace of the fall kicks in. Rather, the recent volatile period may give way to only a brief lull before markets become more restive again.
Recap
For a good stretch of the period, our forecasts for mortgage rates were holding their own, at least until an early-August hiccup in financial markets pressed rates sharply downward, and has since left investors a bit more worried about economic conditions than they have been for much of this year. Back in June, we expected that the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac would run in a range of 6.66% to 7.08%, and seven of the nine weeks fit nicely into that slot before a sharp decline during the final two weeks saw them dip as low as 6.47% during unsettled market conditions.
It's nearly impossible to forecast such extreme moves, especially those caused by unseen technical triggers such as an unruly unwinding of currency "carry trades", which was the proximate cause of August's market turbulence. As such, we'll consider the forecast to be a qualified success.
A less qualified success was seen for the 5/1 ARM forecast. where we expected these shorter-term fixed rate offers to hold between 6.28% and 6.68% for the forecast period. These average offered rates from the Mortgage Bankers Association did have a couple forays into the lower portion of our expected range and hung around the bottom of it for four of the nine-week period. but spent most of the time below where we expected them to travel, sinking as low as 5.91% over the period.
Pricing for this mortgage product tends to be more erratic, since not all lenders can be bothered to offer such ARMs while consumer interest remains squarely on fixed-rate mortgages, even at today's relatively high rates. As well, most ARMs aren't sold to Fannie Mae or Freddie Mac, so there can be a wide diversity in pricing as lenders look to fill portfolio needs. Regardless, and while we'll hope to try to provide a more accurate outlook this time, at least our miss was on the beneficial side of the coin for any homebuyers who may have chosen an ARM.
Forecast Discussion
As mentioned in the Preface, there's an important Fed meeting coming up right in the middle of this Forecast. While the meeting is certainly no secret, what's still a mystery is whether the Fed will move rates a little (most likely) or make a larger move. During the early-August market turbulence, there were some calls for the Fed to make an emergency cut, and perhaps as one as large as 50 basis points. That was more than wishful thinking, as such moves are reserved for real emergencies, like the financial crisis or the onset of the pandemic. As a companion thought, one should consider that if you don't want the Fed raising interest rates every time the Dow Jones Industrial Average rises by 1000 points you shouldn't expect them to lower them when it declines by that amount, either.
The most recent estimate pegs GDP growth at 2.3% for the second quarter, and the latest figure for core PCE inflation was at a steady 2.6% though June, while the labor market is considered to be "normalizing", per Fed Chair Powell's characterization after the last July 30-31 Fed meeting. As such, there's little indication that the Fed would feel the need to cut interest rates by anything more than a quarter percentage point next month. This in mind, and based upon where mortgage and other interest rates are at the moment, a quarter-point move is already "baked in" to today's mortgage rates.
With that quarter-point move already reflected in interest rates, there will likely be little direct impact when the move actually occurs. However, this makes the outlook for monetary policy as conveyed by the SEP the more impactful part of the September Fed meeting. At its last update in June, Fed members expected core PCE to end the year at 2.8% (revised up from 2.6% in the March forecast), so that test is largely being met. The unemployment rate -- currently 4.3% -- was expected to close the year at a 4% rate, so that marker has already been passed, and the June SEP outlook expected that GDP growth would finish all of 2024 at a 2.1% rate (so far, averaging a 2.13% rate, at least through the first half of the year). If everything came together ax expected, Fed members penciled in one or perhaps two cuts in the federal funds rate by year's end (to a median 5.1% rate across all projections). At least through mid-summer, it does look as though Fed expectations are being met, but there's still a third of the year yet to go, and a lot can happen in that time.
If -- and that's a loaded word -- the trend for inflation, growth and unemployment all hold through the July and August data that becomes available before the meeting, the 1-2 projected cuts will likely turn into 2-3 possible cuts, all but guaranteeing that there will be one more rate cut in 2024. So, post-September, investor focus will turn to how strong or weak incoming data appears, and whether or not subsequent cuts will come in November and December in quarter-point increments, or whether a "skip November, half-point in December" cadence is more likely. We'll certainly know more in four weeks.
Even as investors seem to be focused on the negative at the moment -- or at least seem to be reacting more strongly to negative data than positive -- what data might cause mortgage and other interest rates to firm up from here? Inflation would certainly be one influence, but the overall trend for price pressures appears to have returned to a downward path after a flare higher earlier this year. A resurgent labor market could also help power rates higher, but labor conditions have been loosening for some time now, and there doesn't appear to be a significant or sustained burst of hiring lurking in the shadows. A faster pace of growth might do it, too, but even the 2.8% annual pace for GDP isn't strong enough to push rates much higher, if at all.
On the other side, there could be important data that fosters lower interest rates. The labor market could be one of them, since the current level of unemployment is said to be showing that the broader economy is moving toward or is in a recession, at least according to one widely-followed technical indicator. The so-called "Sahm Rule" says that when the three-month average U.S. unemployment rate rises by 0.50% or more from its 12-month low, a recession is underway. With this as a backdrop, any continued rise in unemployment or unexpected slowing in hiring could be enough to press interest rates lower.
Of course, a sudden decline in inflation could also cause rates to drop, but inflation has broadly cooled over time, albeit with some fits and starts. It's more likely that pattern for inflation will continue its recent gradual tilt downward, perhaps even leveling off around current levels for a time. For it's part, overall economic growth has been fair but hardly spectacular of late, and looks to be in a modest-to-moderate pattern in the third quarter so far with few signs of acceleration.
Looking out over the next nine weeks, our estimation is that the prospects for downside surprises are greater than those for upside ones.
Forecast
This forecast period begins with mortgage rates about as low as they have been since early-mid 2023, at least in terms of long-term fixed rate mortgages. We think that the sudden August drop isn't fully sustainable unless there is more poor economic data to reinforce it; so far that has not been the case. However, the newest economic data hasn't yet fostered much of a retracing of the early August decline, but we think this will happen to at least some degree.
We're of the opinion that the coming economic and inflation data will be solid enough as to help dispel expectations for a large move by the Fed in September. In turn, the likely messaging from the Fed and the SEP will suggest that more rate cuts can be expected to come, but that the cadence of cuts and their size will be dictated by the incoming data.
With all this as a backdrop, we think that the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac will likely hold a range between 6.35% and 6.75% over the next nine-week period. There is however a potential for rates to break below the bottom of the range if there is more considerable labor market weakening than we expect over this time.
As far as the initial fixed interest rate for a hybrid 5/1 ARM, we think that the Mortgage Bankers of America survey will find them contained by a 5.85% and 6.25% pair of boundaries between now and mid-October.
This forecast expires on October 17, 2024. We'll be a full month into fall at that point, a full month past the likely first cut in short-term interest rates by the Fed, and the presidential election will be coming up quickly. As you carefully consider your choice for that, why not stop back and see how this forecast turned out? One thing we can all agree upon is that lower mortgage rates would be a welcome change.
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.