Inflation, Fed action set stage for higher mortgage rates

Mortgage rates have hovered near all-time lows for much of this year, even as inflation has increased sharply across much of the economy.

That could begin to change in the weeks to come, now that the United Stated Federal Reserve has signalled it could announce as early as next month plans to begin rolling back the measures it has taken to shore up the economy during the pandemic.

The Fed is widely expected to announce a timetable for reducing its monthly bond purchases at its next meeting in early November. Those bond purchases have helped keep mortgage rates at ultra-low levels for much of the last 18 months.

The yield on the 10-year Treasury note has risen steadily since the central bank’s last policy update in mid-September, reaching 1.64 per cent last week. Home loan rates, which tend to track moves in the 10-year Treasury yield, have also moved higher.

The average rate for a 30-year mortgage climbed to 3.09 per cent this week, the highest level since April, when it peaked at 3.18 per cent, according to Freddie Mac. A year ago, the rate averaged 2.8 per cent.

Signals from the Fed and signs that inflation remains pervasive set the stage for mortgage rates to move even higher in coming months, economists say.

“The biggest influence is that the Federal Reserve is poised to start dialling back their bond purchases as soon as next month,” said Greg McBride, chief financial analyst for Bankrate. “However, in the months ahead inflation will likely be the single biggest determinant of what happens with mortgage rates. Whether or not they go higher, and if so, how much higher.”

McBride expects that long-term mortgage rates will average between 3 per cent and 4 per cent over the next 12 months.

That’s along the same lines as a forecast this week by the Mortgage Bankers Association, which projects the average rate for a 30-year, fixed-rate mortgage to close out this year at 3.1 per cent and then rise to 4 per cent by the end of next year.

The National Association of Realtors also sees rates moving higher from here, reaching 3.5 per cent by mid-2022.

“The Fed will likely raise interest rates by the middle of next year,” Nadia Evangelou, a senior economist at the NAR, wrote in an inflation analysis last week. “When the Fed increases its interest rates, banks do, too. And when that happens, mortgage rates go up for borrowers.”

Last December, the Fed said that it would buy US$120 billion a month in bonds until the economy had made “substantial progress” toward its goals of maximum employment and inflation that averages 2 per cent over time. The bond purchases are intended to spur more borrowing and spending by keeping longer-term interest rates low.

The central bank has also kept its short-term benchmark rate at nearly zero, but rising inflation has turned up the pressure on the Fed to dial-back its low-interest rate policies.

The consumer price index, a key measure of inflation, climbed 5.4 per cent in September from a year earlier, the largest increase since 2008.

Inflation has historically been lower than the average rate on a 30-year mortgage. But since April, inflation has been above the average long-term mortgage rate. The last time inflation ran higher than the average rate on a 30-year home loan was August 1980, according to the Federal Reserve.

With mortgage rates coming off rock-bottom levels – the average rate on a 30-year mortgage hit an all-time low of 2.65 per cent in the first week of January – an uptick in rates is unlikely to derail the ultra-competitive US housing market. But it still means would-be homeowners will have less buying power. It also means homeowners who’ve been considering refinancing may miss their chance to lock in a lower rate.

“The lowest lows may be in the rearview mirror, but mortgage rates are still lower now than anything seen prior to the summer of 2020,” McBride said. “If you haven’t yet refinanced do so now. The likelihood is that we see higher rates, not lower rates in the months ahead.”

The MBA projects that mortgage refinancing will fall 62 per cent next year to US$860 billion from a projected US$2.26 trillion this year.

Even with higher mortgage rates, the housing market is expected to remain fiercely competitive given the shortage of homes for sale relative to demand. As such, the MBA expects mortgages for purchasing a home to increase 9 per cent next year to a record US$1.73 trillion.

AP