Many real estate experts have been viewing a potential rate cut by the Federal Reserve as a leverage that could make housing more affordable. Lower borrowing costs would indeed lead to a decrease in mortgage rates. However, the hope of quickly seeing 2% or 3% mortgage rates is unlikely to materialize in the near future.
In reality, the Fed is more likely to keep the fund rate at a certain high level, even if they do cut rates. It may not be easy for the market to lower mortgage rates enough to significantly push down house prices. Why is that? Let’s analyze further.
Many believe that the high mortgage rates are a result of previous Fed rate hikes, and thus, if the Fed cuts rates, mortgage rates will drop, prompting people to buy houses. However, this wishful thinking is likely difficult to achieve.
There are two main reasons why even if mortgage rates drop, house prices may not plummet. The first reason is that the speed of rate decline may not be rapid. Even if rate cuts begin, there is still a high probability that the 30-year fixed-rate will remain around 6%.
Experts suggest that a drop to 5.5% in rates could spark a buying spree. However, according to Bank of America, the gap between effective rates and current rates is still not enough to incentivize people to purchase homes.
Seth Carpenter, the Chief Global Economist at Morgan Stanley, recently stated in a podcast that the U.S. real estate market may not become significantly cheaper anytime soon.
During the June meeting of the Fed, officials announced a possible rate cut in 2024. Therefore, if the Fed indeed undergoes moderate monetary easing, mortgage rates will decrease as well, but this decline is expected to be gradual rather than a steep fall.
Consequently, even if the rate gap narrows, it may not reduce significantly. Hence, most homeowners in the U.S. currently hold low rates around 3% or 4%, but there is a good chance that future mortgage rates could rise above 5.5% or even 6%. Ultimately, the likely scenario would be a slowdown in price appreciation without a complete housing market crash.
The real estate market is signaling that monetary policy is having a lesser effect on housing compared to historical levels. However, this doesn’t mean monetary policy is ineffective. Experts at Morgan Stanley believe that while the overall real estate market is not at risk of collapsing, monetary policy is still curbing economic activities in a familiar way, slowing down housing sales but not necessarily reducing prices.
Real estate experts have always been focusing on how the Fed’s fund rate will impact the housing market. However, the Fed does not directly set mortgage rates, and its decisions do not directly affect mortgage rates like other financial products such as savings accounts and CD rates. Mortgage rates often change in conjunction with 10-year Treasury yields.
Although the Fed’s policy does set the tone for mortgage rates, lenders and investors closely monitor the central bank, and interpretations of the Fed’s actions in the mortgage market fluctuate, affecting the amounts buyers pay for home loans. In 2022, the Fed raised rates seven times, leading to a surge in mortgage rates from 3.4% in January to 7.12% in October. In 2023, mortgage rates continued to rise, reaching 8% at one point.
In early July, Fed Chair Powell reported to Congress that recent data shows a significant cooling of the labor market compared to two years ago. The unemployment rate has risen for the third consecutive month, reaching 4.1% as of July 5th. Signs of a cooling job market are increasing, putting pressure on Fed officials to decide when to relax monetary policy.
Powell emphasized that cutting rates too early or by too much could hinder or reverse progress on inflation. The Personal Consumption Expenditures Price Index (PCE), a measure of inflation, dropped from a peak of 7.1% in June 2022 to 2.6% in May this year. These figures have relieved some Fed officials, showing a slowdown in inflation following an unexpected rise earlier in the year. However, some officials still want more confidence in the trend before lowering borrowing costs.
Many economists warn that the job market slowdown could worsen further. The number of people actively searching for a job for 15 weeks or more hit its highest level since the beginning of 2022 in June. The job search is becoming more challenging, as employment slows down and job hunting takes longer.
The Fed is now facing concerns beyond just inflation and is also intensifying its focus on the unemployment rate. Democrats cautioned Powell on Tuesday (7/9) that delaying rate cuts could pose risks to the economy, leading to potential increases in unemployment, rising housing costs, and slowdowns in manufacturing. Republicans mostly agree with these arguments.
Many economists point out that the labor market has significantly cooled off, signaling a potential downturn. Balancing ongoing inflation reduction while preventing substantial increases in the unemployment rate poses a challenge for the Fed.
Although the Federal Open Market Committee is unlikely to cut rates at its meeting on July 30-31, the probability of a rate cut in September remains high. According to the CME’s FedWatch Tool on July 12th, there’s approximately a 90% chance of a one-point rate cut.
The speed of rate cuts is crucial. Even with a modest rate cut or no cut at all in July, the impact on mortgage rates might not be significant. As per Mortgage Daily News, the average 30-year fixed rate on July 10th was 6.99%, though it has decreased from earlier peaks this year, it still remains near 7%.
Fortunately, June’s CPI data on July 11th showed a 3% year-on-year increase, down from 3.3% in May. With decreasing inflation, a path is cleared for the Fed’s rate cuts once again, potentially allowing room for a decrease in mortgage rates.
The second reason why a rate cut may not lead to lower house prices is the expectation that sellers might flood the market once mortgage rates drop, causing prices to surge—a scenario detrimental to potential homebuyers.
Chen Zhao, Chief Economist at Redfin, believes that lower mortgage rates will bring both buyers and sellers back into the market, possibly accelerating price increases but could also push prices down, depending on the groups returning more actively. If sellers return faster, prices may cool down; however, if buyers return in higher numbers, prices might escalate.
Robert Reffkin, Co-founder and CEO of real estate giant Compass, recently stated that a 6.5% 30-year fixed rate would be acceptable, but the magical number is 5.9999%; he would signal it’s the ideal rate level for property purchases.
In essence, the pace of rate reductions may not be swift. When rates approach around 6%, experts suggest it could be a good entry point. However, if rates gradually decline this year, it might not have a significant impact on housing supply, as the rate difference is still substantial for existing homeowners, insufficient to motivate them to move.
Moreover, markets with increased supply due to sluggish sales or those with high new housing supply still have chances of price decreases, especially in areas where the market overheated during the pandemic, making them more susceptible to market corrections.
Ultimately, everything hinges on the speed at which the Fed lowers rates; if there is only one rate cut this year, the impact on mortgage rates may be limited. But if August shows promising inflation figures and the possibility of another rate cut arises, the impact on loan rates could be substantial, potentially reaching the 6% level—the last time nearing this figure was at the end of January 2023.
Over the past week since July 5th, mortgage rates have hovered around 7%, slowing loan demand once again, with a 0.2% drop in application volume compared to the previous week, and a 2% decrease in refinancing index.
Looking back to when rates hit 6% at the end of January last year, there were fluctuations in mortgage applications, indicating an increase in purchases despite it being a slow season for the housing market.
Keep in mind that the seasonal trends in the housing market are likely to align with rate movements. This means that a significant drop in rates, especially during the off-season, is a possibility, as has been observed frequently in the past two years. Many experts predict that by the year’s end, with rate cuts and reduced inflation, rates will decrease. However, entering the market during the holiday season may trigger mixed feelings for buyers and sellers on whether it’s the right time to venture into the market. Personal circumstances and the availability of preferred properties might help in making a more informed decision.
So, will rate cuts indeed fail to trigger a decline in house prices? Perhaps it’s still possible. It will rely on the extent of the rate cut and how much it affects mortgage rates. If the reduction is sufficient to attract a surge in market participants, it could prevent a price decline; however, if the decrease is insufficient, continuously impacting buyers’ affordability, the housing market’s prolonged softness will accumulate more inventory, potentially leading to further price drops in certain areas. ◇