For Jill Comfort, who runs her own brokerage, Comfort Realty, in Maricopa, Arizona, 2024 has proven to be a sluggish year in real estate.
Buyers willing to venture into the market have faced unpredictable conditions.
One of Comfort’s clients had locked in a mortgage rate estimate just before the Federal Reserve announced a rate cut. “Subsequently, rates climbed again, and now her monthly payment is set to be higher than what we initially projected,” Comfort explained. “It’s incredibly aggravating.”
This isn’t an isolated incident. On September 18, the day the Federal Reserve implemented its initial rate cut for 2024, the average rate for a 30-year fixed-rate mortgage was 6.09%. Fast forward three months to just after the Fed’s third rate cut of the year, and while the federal funds rate dropped by a whole percentage point, mortgage rates surged to an average of 6.72% by December 19, based on data from Freddie Mac.
Understanding the Link Between Mortgages and Bonds
The Federal Reserve sets the rates at which banks lend money to one another overnight, but mortgage rates, which typically span 30 years, are more closely aligned with the yields on 10-year U.S. Treasury notes. These government-issued securities are actively traded in the bond market.
A recent article by mortgage guarantor Fannie Mae outlined several factors that influence 10-year Treasury note rates, including “investors’ expectations for monetary and fiscal policy, economic growth, and inflation.”
Higher expected inflation leads investors to seek higher yields to maintain the value of their investments. Higher inflation also increases the risk of devaluation of interest-bearing investments, leading to lower bond prices when yields rise, and vice versa.
Exploring the Gap Between Mortgage Rates and Bond Yields
While mortgage rates generally move in tandem with the bond market, there is a significant “spread,” or difference, between the two. For example, on September 18, while the 30-year fixed-rate mortgage averaged 6.09%, the 10-year Treasury yield was at 4.10%.
Mortgages pose a higher risk than government debt because homeowners can default on their loans. Furthermore, homeowners can refinance their mortgages at any time without penalties, which introduces unpredictability in cash flows for investors and institutions holding these loans. Therefore, these entities demand a higher yield to compensate for increased risks.
Rising Mortgage Rates Despite Lower Federal Rates
The primary reason for rising mortgage rates is increased risk. According to Selma Hepp, chief economist at CoreLogic, “Inflation has remained stubborn since last December, indicating that achieving the final reduction to the Fed’s 2% inflation target is proving to be much tougher than anticipated.”
While the Federal Reserve has made strides in controlling rampant inflation, reaching the 2% target appears increasingly challenging. This sentiment was echoed by Fed Chair Jerome Powell during a recent news conference where he remarked that efforts to achieve 2% inflation have been faltering as the year ends.
Hepp also noted that there is no imminent sign of relief in the bond market. Concerns over national debt and deficits persist, alongside expectations of sustained economic growth, which necessitate higher natural interest rates.
Investors are particularly wary of mortgages now, as rates have remained high for an extended period, increasing the likelihood of homeowners opting to refinance, thus heightening prepayment risks.
“We are in a period of notable uncertainty,” Hepp stated. “Pricing mortgages becomes particularly challenging under such conditions.”
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Passionate about analyzing economic markets, Alice M. Carter joined THE NORTHERN FORUM with a mission: to make financial concepts accessible to everyone. With over 10 years of experience in economic journalism, she specializes in global economic trends and US financial policies. She firmly believes that a better understanding of the economy is the key to a more informed future.
