Why Mortgage Rates will fall in 2024

November 4, 2023 · by Andrew Oliver · in Mortgage and Finance News

This article addresses two things: what drives mortgage rates, and why they will fall.

What drives mortgage rates?

The Federal Reserve (Fed) meets regularly and announces, with great fanfare, its “Federal Funds Rate(FFR).” But what is this interest rate and what does it influence?

The FFR is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. It is this rate which impacts the interest rate on many consumer loans, such as credit cards and automobile loans, but NOT 30-year Fixed-Rate Mortgages (FRM).

In general, FRM are sold to Fannie Mae and Freddie Mac and are bundled into portfolios which are sold to investors as Mortgage-Backed Securities (MBS). The yield investors demand for MBS is based upon the yield on the US Treasury 10-year (10T) yield, and the extra yield investors want to buy MBS rather than just risk-free Treasuries.

Look at this chart showing the three rates (FRM, FFR and 10T) over the last year. Note that the Green (FRM) and Red (10T) lines move in tandem, while the blue line (FFR) does not move with either of the other two. Thus, the FRM is determined by the yield on 10T, which is set by the market, and not by the Federal Reserve.

The Spread
The spread – reflecting the extra yield investors want to buy MBS – between FRM and 10T this year has between 2.5% and 3.2%. That is unusually high, as we shall see.

Why Mortgage rates will Fall
And now to the forecast. The spread between FRM and 10T is much higher than it is in “normal” times. Look at this chart going back to 2005:

For most of the last 18 years the spread has been in the 1.6 – 1.8% range and has average around 1.75%. The exceptions have been:
2008 – the Great Recession and the height of the foreclosure crisis making mortgages unattractive to investors, who demanded higher yields
2020 – at the outset of the pandemic, amidst widespread uncertainty, spreads widened before the Fed started its huge program of pouring money into the economy, buying both Treasuries and MBS and igniting an asset boom
2022-23 – when the Fed finally, belatedly, stopped injecting liquidity into the system, the market reacted to two main factors: the Treasury would need to sell a lot more Securities to fund the spending, and the growing Budget deficit; and the biggest buyer of Treasuries – the Fed itself – was switching from being a buyer to a seller.
This resulted in the most basic economic equation – more sellers than buyers, so the price of Treasuries went down and the yield (which moves inversely to the price) went up.

How far will mortgage rates fall?
Few if any forecasts have been accurate over the last few years, so it would be foolish for me to suggest a timeframe.
What is less foolish is to suggest that the era of cheap money over the last 15 years has ended. It is only in that period that the yield on 10T has been below 4%, and a sustained return to a 4% yield on 10T is likely.
That in turn would suggest a sub 6% FRM.
Not 3%, but better than 7.7%.