You may have heard on the news that the yield curve has inverted. Say what? you might be thinking. Here’s the what, why and wherefore – and the impact it may have on the housing market
In normal times (whatever they may be) a lender expects to be paid more the longer the length of time she is lending money. Thus, the yield offered on a very short-term security, the US Treasury 3 month Bill (3M), would normally be less than that on the 10 year note (10T).
The chart below shows the yields on the two since the beginning of 2018. In January, the spread – the difference between the two yields – was 1.25% (2.66-1.41). Over the course of the last 14 months that spread has steadily narrowed until, on Friday this week, the yield on the 3M at 2.44% was greater than the 2.42% offered on the 10T. That situation is called a yield inversion.
What It Means
As Investopedia explains: “Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle.” But recessions have generally occurred 1-2 years after the inversion.
According to Barron’s: “If bond investors are bullish on the economy and believe interest rates will go up, they are more willing to hold short-term bonds and hope to harvest the higher yields later on. On the flip side, if bond buyers believe the economy is heading downward and interest rates are likely drifting lower, they’d prefer to hold the longer-term bonds in order to lock in the current higher yields.”
Bear in mind, the actions of the Federal Reserve impact only short-term rates. Long-term rates are market driven.
Impact on Mortgage rates
Regular readers of this blog are aware that the 30 year Fixed Rate Mortgage (FRM) is influenced by the yield on 10T. The chart below shows the FRM together with the yield on 3M and 10T.
At the beginning of 2018 the spread between 3M and FRM was 2.74%, but that has dropped to 1.82% currently. The spread between FRM and 10T, however, has been remarkably constant, averaging 1.7% over that period, as it has for several years.
Thus, a simple way to estimate the FRM is to follow the yield on 10T and add 1.7%. This spread will, of course, fluctuate, but for several years it has been in the range 1.6-1.8%.
Where are mortgage rates headed?
Since 2014 the Mortgage Bankers Association (MBA) has been forecasting that the FRM would reach 5% by the end of the next year. And last November, when the FRM reached 4.94%, it looked as though its forecast might finally be correct. But then came the stock market sell off, the flight to the safety of US Treasuries, and by year end the FRM had dropped back to 4.55%. This week it was 4.28%, but that reflected rates earlier in the week. Next Thursday, when the Freddie Mac FRM is announced, I expect it will drop back towards 4.1%.
And a lender I work with is already offering a 30 year mortgage, with no points, at 4% (and 15 year at 3.5%) for loans up to $2 million. (Contact me for an introduction).
Housing Market Outlook
In late December I published Is a recession coming soon? I concluded that article by saying:”Confidence is a fickle thing. At the moment it is intact. As long as that remains so the likelihood for 2019 is a slowing, but still growing, economy and a stable housing market.”
Evidence grows almost on a daily basis that the world economy is slowing down. The US may be the strongest major economy, but it is not immune from the slowdown that is taking place. It seems more likely that economic activity in 2019 and 2020 will come in below expectations than above. But that does not mean that a recession is imminent, and my conclusion in December still seems a reasonable expectation.
And a mortgage rate of 4% for the first time since January 2018 should provide an incentive to buyers.
Realtor, Sagan Harborside
Sotheby’s International Realty
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