Viral Woes Damping Rates

July 23, 2021 -- As the Delta variant of COVID-19 seems to be getting a stronger footing in many locales, optimism about a faster and fuller pace of economic recovery has diminished to a degree. In the days ahead, the spectacle of an Olympics being held without spectators and fans will certainly serve to reinforce the dimmer atmosphere. Last year, televised sporting events held without fans piped in crowd noise, and this will be the case again, but this only serves to reinforce the feeling of distance and emptiness that the on-going pandemic still brings wherever it goes.

With a somewhat diminished outlook, investors across the globe are trying to decide where to place funds to their best effect. After a long run-up in stock prices, the turn to the new fiscal quarter a few weeks ago saw a bit of a shift away from the relative riskiness of equities to the relative safety of bonds, perhaps as a way to lock in some of the earlier gains. The flare in coronavirus cases only seemed to exacerbate this sort of move in recent days, but stocks appear to again be gaining favor, with new record highs for the major U.S. indexes having again been set.

Investors pushing their funds into bonds aren't necessarily located here, though. U.S. Treasurys are favored by investors across the globe, not only for their liquidity but also because they are available at some of the highest yields among sovereign bonds, too, and that even after currency exchanges are taken into account. In other places, with COVID-19 interrupting things, being able to obtain a positive return (even a small one) from a U.S. bond may be better than lesser or even negative returns available in domestic bonds or those from other places.

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Even if marked down a little bit, the prospects for growth here in the U.S. and in several other major economies remain solid. Presently, the GDP run rate for the second quarter is reckoned to be 7.6%, and looks to best the very solid first quarter rate of 6.4%, so the present sogginess in bond yields isn't related to a weakening growth profile, at least not yet. The downturn in yields is also rather at odds with the present level of inflation, running at multi-year or even multi-decade highs. Certainly, it may be partially reflective of a coming shift in Fed policy, as whatever beneficial effects from QE-style bond buying and short-term rates anchored near zero have provided will start to be removed at some point, but perhaps not for many months or perhaps even a year or more yet.

So it would seem that market sentiment has shifted a bit, at least in the perception that the strongest portion of the recovery is falling behind us. Certainly, that's possible, but this quarter's robust growth should put the totality of the economy at a place above its prepandemic level, even as there remain holes yet to fill in terms of employment and more. It's likely true that the strongest percentage gains in GDP are in the rearview mirror, but no one can realistically expect that such hot growth can persist forever without consequence. In fact, settling back to a more sustainable pace -- even the plodding one that was core of the longest expansion in history until the pandemic killed it -- is welcome, more predicable, and more manageable for both monetary and fiscal policy.

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For whatever the reason they are here, lower mortgage rates are currently both the bane and boon of potential homebuyers. Bane, as lower rates can incent more demand for housing at a time when supply is still short, and bane in that such demand continues to fuel record high home prices. The boon of course, is that for a time, lower rates can help provide some offset to higher mortgage amounts, but this beneficial effect has passed since the multi-year decline in rates came to an end a while back. Right now, lower rates are arguably a greater help to those who own homes rather than those who are looking to own them.

Sales of existing homes broke a four-month streak of gentle declines in June, posting a 1.4% increase to a 5.86 million annualized rate. A somewhat greater number of homes for sale allowed for the increase, since a 3.3% increase in available inventory (to 1.25 million homes) was happened during the month. Of course, this was still an almost 19% lower level of homes available to buy than was seen a year ago, but the improvement did mean that 2.6 months of supply at the current sales pace was available (closer to six months is considered optimal). Of course, firm demand amid limited supply saw the National Association of Realtors also reporting that home prices remained on a tear, sporting a 23.4% increase compared to year ago levels, and a record nominal median cost of $363,300 for the month.

Using median existing home prices from the last two Junes compared to this one, the beneficial initial effect of lower mortgage rates can be seen before the leap in prices overwhelmed it this year. In June 2018, a median priced home in June had a cost of $285,700; mortgage rates at the time were 3.80% and with a 20% down payment the monthly principal and interest payment was $1,065. Last year in June, prices had accelerated mildly, up just 3.5% compared to 2018 to $295,300 but rates had slipped to 3.16% by that time, so the monthly payment was actually lower ($1,017) despite the higher home price. This year, the benefit is lost; rates in June averaged 2.98%, but this June's median $363,300 price lifted the monthly P&I payment to $1,222. Sharply higher prices have wiped out the cost benefit of lower rates, crimping affordability for at least some homebuyers.

Eventually, higher mortgage rates, more supply and rising incomes will damp demand and help temper price increases. However, even if sales cooled considerably from present levels soon it may take some time before the supply of homes has become balanced enough as to cool price increases to something closer to normal, as they were until about mid-2019 or so.

Adding more supply of new homes may in turn allow for there to be greater supply of existing homes available, but it's not a simple or instantaneous process. Housing starts did increase by 6.3% in June, rising to a 1.643 million annual rate, so there are steps in the right direction. Starts of single-family homes rose to a 1.160 million rate, firming up by 6.3% while those for multi-family homes managed a 6.2% gain to 483,000 units underway. Permits for future activity were more subdued, sliding by 5.1% to a 1.598 million rate, likely reflecting the surprisingly softer pace of sales that occurred in May. We'll find out how new home sales fared in June next week.

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Sales probably rebounded a bit from May's 769K pace, if the Housing Market Index from the National Association of Home Builders is any indication. For July, the HMI did settle back by a point to a value of 80, still very robust if still in a gentle fade from a record high last November. Sales of single-family homes posted an 86 (from 87), also still very strong, and expected activity over the next six months strengthened by two points to 81, so optimism among builders remains strong. Homebuyer inquiries were off a bit, with this index component tailing by 6 points to 65, but there's still plenty of demand to keep builders busy.

Applications for mortgages eased back in the week ending July 16 after a good bounce the week prior. The 4% decline in requests for mortgage credit came from a 6.4% dip in purchase-money mortgage queries, while those for refinancing settled back by 2.8%. The decline in mortgage rates this week should pull a few more homeowners in for a refinance, as conforming 30-year mortgage rates are only about an eighth of a percentage point above all-time lows.

That said, there could be a chance at even lower rates by waiting. The Federal Housing Finance Agency last week announced that the half-point "Adverse Market Refinance Fee" being added to mortgages backed by Fannie Mae or Freddie Mac will be dropped starting August 1. That half-point fee, if added into the interest rate (as is common in refi transactions) would lift the borrower's rate by about an eighth of a percentage point or so, so the elimination of the fee should allow somewhat lower mortgage costs for homeowners trading out of old mortgages for new.

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That the economy has cooled of late from a more rapid pace can be seen in the June edition of the National Activity Index from the Federal Reserve Bank of Chicago. This 85-component amalgam of economic indicators seeks to show whether the economy is growing above or below its "potential" or ability to grow without becoming imbalanced. For June, the 0.09 value suggests slightly above-trend growth happened during the month, closing the second quarter of 2021 on a positive note. We'll see how the economy in the second quarter fared when the preliminary GDP report gets released on Thursday; the period should be plenty strong. As well, and based on the 0.7% increase in the Conference Board's Index of Leading Economic Indicators for June, there should probably be plenty of momentum to carry growth forward through July and August, if not beyond.

Initial claims for unemployment benefits popped higher in the week ending July 17, rising by 51,000 for the week and landing at 419,000. Adding to this another 110,000 special Pandemic Unemployment Benefit requests brought the total over 500,000 for the first time in several weeks. That said, auto-plant retooling and seasonal adjustments may be behind the flare in claims, and the general trend in the labor market is still that there are more jobs available than bodies willing to fill them, so there's not a lot to worry about in the lift in claims last week.

Current Adjustable Rate Mortgage (ARM) Indexes

IndexFor The Week EndingYear Ago
Jul 16Jun 18Jul 17
6-Mo. TCM 0.05% 0.06% 0.14%
1-Yr. TCM 0.08% 0.08% 0.15%
3-Yr. TCM 0.44% 0.40% 0.18%
10-Yr. TCM 1.36% 1.51% 0.63%
Federal Cost
of Funds
0.785% 0.806% 1.158%
30-day SOFR (daily value) 0.01133% 0.10134%
FHLB 11th District COF 0.306% 0.343% 0.755%
Freddie Mac
30-yr FRM
2.88% 3.02% 3.01%
Historical ARM Index Data

The Federal Reserve meets again next week to discuss all of this and contemplate what to do. While no change to monetary policy is expected, it is expected that the discussion of when and how quickly to begin to taper QE-style bond-buying programs will take place. However, while the statement that closes the meeting will reveal no specific clues, more may come in the post-meeting press conference. If not, we'll have to wait three weeks until the minutes of the meeting are released to get a sense of the central bank's intentions.

Presently, interest rates are a little lower than might be expected, given economic conditions, but most likely again being influenced by the ebb and flow of COVID-19 concerns. It may also be that typical summer market conditions are also partly to blame for the more erratic moves of late, as vacations and thinly-populated trading desks help create stronger turns in one direction or the other, and especially toward defensive positions amid uncertainty.

A mixed bag of new economic data is due out next week, and there is the Fed meeting to consider, of course. Based on how the bond market finished this week, it appears as though the dip in rates is over for the moment, barring any early-week bad news. To us, it looks as though the average offered rate for a conforming 30-year FRM as reported by Freddie Mac next Thursday morning will be unchanged or perhaps up by a basis point, but upward traction for rates has been hard to come by of late.

For a look at where we think rates are headed beyond next week, and what we expect them to do until mid-August, check out our latest Two-Month Forecast for mortgage rates.

We've just completed a mid-year review of our 2021 Outlook to see how our prognostications for a range of topics are coming along. Have a look and see how we're doing so far in '21.

For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".

In most areas, home prices have been rising for years. If you're curious about how much home equity you have -- or will have at a future date -- you should check out HSH's KnowEquity Tracker and Projector, our unique home equity calculation and forecasting tool.

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