High Mortgage Rates and a Stalled Housing Market

Morgan Stanley’s co-heads of securitized products research say they will discuss the reasons behind the sharp rise in rates and its implications for the housing and mortgage markets, noting that the 10-year Treasury yield has exceeded 5.3%, reaching its highest level since 2002 and that 30-year mortgage rates have reached 7.5%, up since month 2 by 150bp. They explain that Treasury yields are the biggest driver of mortgage rates. Rising rates lead to fewer moves and longer average maturities, creating a convexity-hedging feedback loop in which investors sell to maintain their duration, pushing rates higher still. However, with the average rate on outstanding mortgages at 4.5%, leaving them 300bp out of the money, the impact is limited. They say a 7.5% rate has increased the monthly payment on a median-priced home relative to the low in month 2 by 325 dollars, or 17%, but because more than 90% of mortgages have fixed rates, existing borrowers’ payments remain unchanged, and only marginal buyers’ purchasing power deteriorates. With leading indicators cooling, including pending sales declining for 2 consecutive months by 3~5% year over year and purchase applications in month 9 falling 10%, they expect the share of transactions to remain trapped in a range at its lowest level in 40 years. They explain that despite slowing demand, the lock-in effect has curtailed growth in existing-home listings, accelerating price growth from 0.7~0.8% to 1.9%, and they expect growth of around 2% to continue through year-end. They say the share of adjustable-rate mortgages rose in the first half of the year from the 15% range to the 16% range, providing help at the margin in a market with annual issuance of 2 trillion dollars. The 5/1 and 7/1 and 10/1 products driving that growth behave like fixed-rate mortgages when borrower characteristics are controlled for, making responsible expansion possible, contrary to concerns about a repeat of the financial crisis. All forecasts about direction are the speakers’ conditional judgments, not definitive predictions of short-term prices.