Recession fear intensifies as Fed doubles down on rates - Movement Mortgage Blog

The wild ride of the post-pandemic housing market continues as fears of a recession gain steam for investors. The volatility can be easily shown in the bond market. This last Thursday the yield on the 10-year Treasury note, which typically sets the trajectory for mortgage interest rates, dipped to just above 3.00%—its lowest level since June 9. The 10-year quickly bounced back and opened Friday morning trading at 3.104%.

Much of this mixed sentiment is due to uncertainty about how the Federal Reserve will handle its quantitative tightening (QT) policy and how well it will work to tame inflation. Speaking on Thursday, Fed Chairman Jerome Powell said the Fed has an “unconditional” commitment to slowing inflation.

Powell’s concession while speaking to the U.S. House of Representatives Financial Services Committee is that sharp moves upward for interest rates—in this case the federal funds rate which is what the Fed controls—could affect employment. As it becomes more expensive to borrow money, companies are less likely to hire more employees to increase production because it’s just more expensive to do so. This week, Powell noted that while unemployment might rise during this period of QT, restoring price stability is “something we need to do.”

Another thing that typically happens when the Fed raises the federal funds rate is mortgage interest rates rise, which we are absolutely seeing now. However, that rise in rates typically correlates with a steep drop in home prices. We are not seeing that happen yet, at all. The last couple of readings from the S&P CoreLogic Case-Shiller National Home Price Index show that home prices are gaining steam despite the rising interest rates. April’s home prices rose at a pace of 19.8% even though rates were flirting with 5% at that point. 

Right now the lack of inventory is a huge factor in why home prices remain high. Over the last two years we saw millions of Americans refinance their homes instead of selling them in order to save money during the pandemic. In many cases, Americans cashed in on their equity with a cash-out refinance at the much lower interest rate. When you combine that with other factors such as older Americans staying in their homes longer and the seemingly insatiable demand for homes due to urban flight during COVID, you have a recipe for extremely low supply. 

Furthermore, new home construction is not nearly as strong as it once was. A large part of the problem in the 2007-2008 housing crash was that there were so many homes and not enough demand which helped facilitate the precipitous drop in home values. We don’t have that now. The National Association of Home Builders’ builder confidence index is at its lowest point in two years. Essentially, they can’t feel confident that the homes they’re building will sell. Due to supply chain issues, the cost of labor and materials have skyrocketed which makes it tougher to build in a cost-effective manner. The median sales price for a newly constructed home in May 2022 was $450,600—up from $376,600 just a year earlier, according to the latest report from the U.S. Census Bureau.

Sales of existing homes showed their weakest reading in two years, according to data from the National Association of Realtors. Existing home sales in May dropped by 3.4% month-over-month with sales 8.6% lower year-over-year. Lawrence Yun, the NAR’s chief economist, said “I do anticipate a further decline in home sales.” 

However, declining home sales don’t always correlate to lower demand. Freddie Mac’s latest 30-year fixed-rate mortgage average came in at 5.81%—a full two points higher than the start of 2022. Freddie Mac’s economists said in their release, “The combination of rising rates and high home prices is the likely driver of recent declines in existing home sales. However, in reality many potential homebuyers are still interested in purchasing a home, keeping the market competitive but leveling off the last two years of red-hot activity.”

Essentially, people still want a home they are just continuing to get priced out thanks to much higher rates and already high home prices that keep climbing. One option that many homeowners are looking toward is an adjustable-rate mortgage (ARM) loan. A lot has changed since ARMs were largely blamed for the housing market collapse in 2007-2008. Stricter lending laws have helped take some risk out of the loan product and, since the interest rate can be significantly lower than a fixed-rate, it is an appealing option for borrowers looking for a break in affordability.

There is still a good amount of risk involved with an ARM loan and it is best to discuss every possible option with your Movement Mortgage loan officer to get a complete picture of affordability when it comes to your homebuying process.

About the Author:

Movement Staff

The Market Update is a weekly commentary compiled by a group of Movement Mortgage capital markets analysts with decades of combined expertise in the financial field. Movement's staff helps take complicated economic topics and turn them into a useful, easy to understand analysis to help you make the best decisions for your financial future.