Mortgage Rates Gently Rising from Recent Lull


Since 2006, mortgage interest rates
have fallen 242 basis points, from 6.41 percent to 3.99 percent.  A decline of 246 basis points in the 10-Year
Treasury Note during the same period was largely responsible for the change. However,
during the first two years of this period, from 2006 to 2008, the risk premium rose
by 78 basis points. Michael Neal, writing in the National Association of Home
Builders (NAHB) Eye on Housing blog, says it was this premium that was targeted
by federal monetary policy and those policies were partly responsible for its
decline. The current risk premium, 1.66 percent, is only 4 basis points higher than
it was in 2006, before that spike.

After nearly 12 years of low rates, often
historically so, rates are on the move again.  The Federal Housing Financing Agency’s (FHFA’s)
data on purchase mortgages for newly constructed homes indicates there was a 7-basis
point rate increase in November to 4.00 percent, still below the 4.18 percent
peak recorded in February. Meanwhile, Freddie Mac posted a 2-basis point increase
in its rate in November to 3.92 percent and another 3-basis point gain in
December. Neal says that despite the differences, the two series track each



Because the FHFA series includes only
new construction purchase mortgages, Neal uses the more frequently cited Primary
Mortgage Market Survey from Freddie Mac to analyze the performance of rates
over the course of last year.  Over the
12 months, the 30-year fixed rate rose 34 basis points to 3.99 percent, ending
the year under 4.0 percent for the fifth time in six years, while the 10-year
Treasury Note was up by 49-basis points. As illustrated by the figure below,
that difference is accounted for by a 15-basis point decline in the mortgage
risk premium which started the year at 1.81 percent.



Breaking the 10-Year Treasury Note
rate into its components of real return and inflation compensation, suggests
that both contributed to the note’s 2017 increase. Inflation compensation rose
by 30 basis points to 1.87 percent while the real return, taken from the rate
on the 10-Year Treasury Inflation Protected Securities (10-Year TIPS),
increased by 19 basis points to 0.46 percent. However, the low 2017 rate on the
10-Year Treasury Note, when compared to the local peak rate in 2006, reflects a
depressed real return
. The real return in 2017 was 185 basis points below the level
in 2006 while the inflation compensation component was 61 basis points lower.



In 2012, the real return fell to
negative 0.48 basis points which means investors were paying, in real terms, to
lend money to the government
.  This rate
shifted from negative to positive, Neal says, in response to the Federal
Reserve’s first announcement about unwinding its bond purchases; the so called “taper
tantrum.” Neal says his earlier analysis illustrated how, when the Fed actually
did begin to normalize its balance sheet in October 2017, it was reflected by a
rise in the real return on the 10-Year Treasury Note rate. “Combined, these two
events beg the question whether Fed bond purchases, either actual or expected,
are related to the decline in the real return over the last downturn,” Neal

In the figure above, the real return
on the 10-Year Treasury Note, with the natural log of Fed holdings of
longer-dated US Treasury securities (those maturing in 5 years or more) is plotted
on the left axis. The natural log is used as a proxy for the growth in Fed
holdings, most likely resulting from purchases. The right-hand (secondary)
axis, which plots the Fed purchase volume, is inverted so that the increase in
bond-buying corresponds to a decline in the curve.

Neal said it appears that the real
return on the 10-Year Note rate tracks the growth in Fed purchases of longer
dated Treasury Securities between 2003 and 2012 with the tightest correlation occurring
between 2008 and 2011.  The 2013 normalization
comments from the fed reversed the trend of the real return as expectations
were priced in, even as the Fed continued to purchase.  Since 2014, the real return has remained
above the trend in Fed holdings of longer-dated Treasury securities, but the
gap between the two has shrunk
. It is possible that a third dynamic such as a
recession or stronger economic growth
, is responsible for both the increase in
Fed purchases and the decline in the real return.

Original Source