Home sales will resist the rate hike

Fannie Mae made some modest changes to his economic projections this month, as consumer spending in January was above expectations and interest rates rose. The company’s Economic and Strategic Research (ESR) group expects 2021 GDP growth to be 6.6% instead of its previous forecast of 6.7% and to drop from 2.8% to 2022 at 3.0%. Compared to last month’s forecast, they also expect a slightly stronger recovery in consumption, but a longer expansion of public spending and a slightly slower pace of private investment spending.

A downside risk to the forecast is the possibility of the emergence of a more resistant viral variant, leaving the future trajectory of the virus a short-term risk. The biggest uncertainty, however, is how quickly restricted social distancing activities will recover.While businesses and consumers are reluctant to resume pre-pandemic activities, the strong 2sd and 3rd growth for the quarter may not materialize. On the positive side, household savings are extremely high; current accounts alone held $ 3.2 trillion in Q4 2020, $ 2 trillion more than the pre-COVID benchmark. If consumers spend those balances along with their stimulus check, consumer spending could be higher than Fannie Mae’s robust projections.

The company does not believe that rising interest rates to date are a major concern and modest further increases would likely reflect a healthy and recovering economy. They see, however, that if inflation expectations continue to accelerate, it could lead to a larger rate hike. While the absolute level is still modest, measures of market-based inflation expectations, such as the 5-year TIPS / Treasury spread, have risen significantly in recent months, indicating growing investor apprehension of the upside. prices.

Economists call the rise in long-term interest rates probably the most notable development of the past month. The 10-year Treasury rate at the time of going to press was 1.63%, down from 1.09% in early February. The level remains modest, the 10-year Treasury rate averaged 2.32% from 2011 to 2019, but the rise was rapid. Even though inflation expectations remain subdued, with the nominal GDP growth forecast, it is quite plausible that the 10-year Treasury rate could reach the 2.5-3.0% range by the next year. end of 2022.

They do not believe, however, that the pace of increases will continue, that rates will rise only slightly higher for the rest of the year, and that the Fed will maintain its accommodative policy. until inflation clearly exceeds its 2.0% target for a long time.

The 30-year fixed mortgage rate is likely to rise less quickly than the 10-year Treasury bill in the short term. The increase of around 55 basis points in the 10-year Treasury since early February was equivalent to an increase of around 30 basis points in the mortgage rate. Over the past year, a sharp increase in arrangements has led lenders to increase their operating capacity. Therefore, in the short term, initiators are likely to absorb some of the increased financing costs to maintain production volumes.

With higher mortgage rate forecasts, Fannie Mae has modestly lowered its home sales forecast for 2021 from an increase of 6.9 from 2020 last month to 6.2%, but stress that rates will not be the main driver of the slowdown. Rather, it will be due to the weakening calendar effects of the delay or advancement of homebuyers’ purchases due to COVID-19 and extremely tight inventory limiting transactions. A large number of buyers should be able to absorb slightly higher mortgage rates in the short term and therefore an upward drift in rates will have minimal impact on sales. Downward revisions to mortgage loan forecasts are more severe because refinancing activity is highly rate sensitive. Total creations in 2021 were raised to $ 3.9 trillion from $ 4.1 trillion and projections for 2022 were lowered from $ 3.2 trillion to $ 2.9 trillion.

However, if rates rise more aggressively than the baseline forecast, economists invite a comparison with 2018, the last time rates saw a period of significant hikes. The 30-year mortgage rate has risen just over 100 basis points in 14 months. On a quarterly basis, total home sales fell about 8% from peak to trough, despite continued employment and income growth. If something similar were to happen in the next year or so, there is reason to believe that the sales drag would be considerably weaker.

First, the “lock-in” effect will be weaker. When rates hit 4.9% at the end of 2018, a seven-year high, most potential buyers had likely bought homes or refinanced their notes at rates below the going market rate, creating a deterrent to move to a new house. On the other hand, even if mortgage rates stood at 4.0% today, that would still be a lower rate than that prevailing for most of the last decade. Most homebuyers don’t move within a year or two of the purchase or within a year of refinancing. Thus, the foreclosure effect should be relatively attenuated over the next two years if rates do not exceed around 4%.

Second, rates are still historically low, keeping mortgage payments relatively affordable relative to income. and well below the peak of 2018, although house prices have appreciated rapidly. To reach the 2018 pay-to-income ratio today, the 30-year rate should be around 3.9%.

More home buyers are likely to be able to absorb higher payments. Given the high savings rate, credit card balances that have been paid off by $ 118 billion in the past year, and stimulus payments, the pool of potential buyers has debt-to-income ratios ( DTI) lower, higher credit scores and a greater possibility of making larger down payments compared to 2018.

The current limited supply of homes for sale is likely hampering transactions with many potential buyers unable to find a suitable or overbid home. Even though some buyers are pulling out of the market due to rising rates, there is likely a large “pool” of buyers to fill their space in the short term. Appreciation is likely to subside as bidding wars subside, but the effect on transactions would be limited. Additionally, home builders are currently struggling to keep up with demand, suggesting they will continue to build a brisk pace even if traffic slows down.

Considering these factors and with the future course of interest rates uncertain, one scenario used by the ESR group was that mortgage rates (relative to the baseline scenario) increase by an additional 50 basis points by the end. 2021 and 85 basis points by the end of the year. end of 2022. With other relevant factors unchanged, this translates into a 30-year fixed mortgage rate of 3.7% and 4.3%, respectively, a range more typical of the pre-COVID period discussed previously.

This resulted in only a modest reduction in home salescompared to the baseline of about 1.0 to 2.0 percent in 2021. Declines in 2022 were somewhat larger, from 4.0 to 5.0 percent (again from baseline), as some of the factors mentioned above are decreasing, but the softening is still modest compared to the past.

Consistent with this view that home sales will only be modestly affected by recent rate hikes, the forecast for purchase mortgage origination volume is up 13% from 2020, at $ 1.8 trillion. This is due to expectations of higher home sales for the entire year this year compared to last year, as well as continued price appreciation. However, Fannie Mae revised his refinancing estimates down 6% from his February forecast to an annual volume of $ 2.1 trillion. Demand activity suggests that refinancing volumes will remain high in the first half of 2021 before declining in the second half, as the mortgage rate is now expected to rise faster than previously thought. The forecast for the 2022 refinancing volume has also been revised down from about $ 240 billion to $ 1.1 trillion.

While higher rates have led to a downward revision, even at the current rate of 3.1%, Fannie Mae estimates that 48% of all outstanding mortgage balances have at least half a percentage point of incentive to to refinance. However, returning to the alternative scenario where the 30-year fixed rate is 3.7% by the end of 2021 and 4.3% by the end of 2022, refinancing arrangements would likely drop. about 14% from baseline this year, and about 44% lower in 2022.

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