Could This Graph Mean Lower Mortgage Rates on the Horizon?

One of the more fascinating aspects of the recent upward interest rate trends is the spread between mortgage interest rates and the yield of the 10-Year Treasury Note.

Generally, we assume that the average mortgage interest rate will be between 1.7% to 2.25% higher than the yield of the 10 Year Note. However, in recent months we have watched that spread jump to over 3%.

As you can see from the Bloomberg image below, this is the widest spread we have seen in recent decades. With the Federal Reserve committed to reducing its investments in the mortgage market, large bond investors have been more cautious and less willing to buy mortgage bonds.

The good news in this graph is that anytime we have seen a large spread between the two, it was immediately followed by a quick recovery. This could mean that the 10 Year Note yield jumps higher soon, or that mortgage interest rates come down. Let’s hope for the latter.

With more recent reports showing inflation is running at a hotter pace than anticipated, the projection for how far the Fed will need to hike rates continues to move higher.

Barclays upgraded their policy outlook to call for ¾% hikes in both November and December, and a ½ point hike in February. This has moved their projected peak hike from 4.5-4.75% up to 5-5.25%. However, they further anticipate that the Fed will be forced to cut rates before the end of 2023.

One key change in recent weeks has been the number of economists who now believe the US heading into an imminent recession. Highly respected economists are now admitting they missed the market in their original belief in the soft landing theory.

Now, nearly 100% of major institutions are preparing for a recession. What this likely means for mortgage interest rates is more pain in the near term followed by lower interest rates at some point in 2023.

Mortgage bonds are performing well in early morning trading. However, recent history shows that any improvements to mortgage rates are short-lived. If you choose to float, do so only while closely watching the bond market.

Be prepared to lock should sentiment reverse.