Mortgage rates fall but homebuyers need more help. Here's why.

The U.S. economy ended 2023 on a high note, with solid consumer spending and a modest uptick in activity from the manufacturing sector, but investors are also seeing improvement in what could be the linchpin for growth prospects this year and beyond.

Bond investors have largely dictated the direction of financial markets over the past year. Falling Treasury yields have either led stocks higher on the heels of slowing inflation data, or prompted investors to trim gains as price pressures quicken and the prospect of Federal Reserve interest-rate cuts dims.

But Treasury yields also play a crucial role in the housing market. Ten-year notes are tightly linked to benchmark 30-year mortgage rates, which set the tone for both home affordability and refinancing demand. 

Core inflation, which strips out food and energy costs and is closely tracked by the Fed, slowed to the lowest levels in nearly three years last month, pulling both Treasury yields and mortgage rates south in the process.

The Mortgage Bankers' Association, in fact, reported Wednesday that the average 30-year fixed rate fell to 6.75% last week, near to the lowest in a month. New loan applications jumped 9.2% to the highest level in nearly six months. Refinancings were also on the rise, jumping 11% compared with the start of the year.

Mortgage rates slide as bond yields drop

“Mortgage rates declined across all loan types as Treasury yields moved lower last week on incoming inflation data, which helped to support a rise in mortgage applications," said Joel Kan, the MBA's deputy chief economist.

"Although purchase activity is lagging year-ago levels, refinance applications have improved from their recent low point and have been showing year-over-year gains, albeit at low levels," he added. 

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"If rates continue to ease, MBA is cautiously optimistic that home purchases will pick up in the coming months.” 

Homebuilders are similarly optimistic, according to the closely tracked survey published Wednesday by the National Association of Homebuilders and Wells Fargo.

Sentiment rose to the highest levels since September, thanks in part to the fall in overall mortgage rates, as buyers looked to the market for new homes in the face a dearth in existing homes available for sale. 

That's led to two big changes in the housing market. First, existing-home sales fell to the lowest levels in 13 years late last fall. But average prices rose 3.4% to around $391,800 as borrowing costs remained elevated and owners were reluctant to sell and take on higher-rate mortgages. 

Rate-cut bets could prove key for homebuyers

But with bond investors now pricing in at least three, and possibly six, quarter-point interest rate cuts from the Fed this year, mortgage costs are set to tumble, unlocking a housing market that has always been a key driver of domestic U.S. growth. 

CME Group's FedWatch, a tool market watchers use to gauge the likelihood of changes to the Fed's key rates, suggests a 55.7% chance of a quarter-point rate cut in March. The odds of a follow-on move in May – including larger increases of as much as half a point – are pegged at 45%.

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"Homebuilders are clearly feeling more optimism on two fronts," said Selma Hepp, chief economist at CoreLogic. "The first is the prospect of lower mortgage rates through 2024. This will help bring more homebuyers back to the purchase market."

"On the other side, housing starts are not keeping pace with the demand, so the amount of homes available for sale will remain tight," she added. 

NAHB Chairman Alicia Huey noted that single-family housing starts are likely to grow this year, "adding much needed inventory to the market." But she cautioned that "builders will face growing challenges with building-material cost and availability."

A faster pace of housing starts thus may take time. Economists expect the Commerce Department's update for December activity to show an overall decline in new units of 8.5% and a modest 1% increase in permits for new construction, a good indicator of forward demand. 

"The bigger picture is that the absolute level of activity in the housing market remains extremely low, and the speed of recovery from here likely will be slow," said Ian Shepherdson of Pantheon Macroeconomics.

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