U.S. interest rates are soaring and potentially signaling the end of an era. For financial markets, higher benchmark Treasury yields are encouraging a swift rotation away from expensive growth stocks and into shares of companies with more stable cash flows. For the broader economy, it’s a return to something resembling normal after the Federal Reserve slashed the cost of borrowing to record lows in the wake of the Covid-19 pandemic.
One area where Wall Street and Main Street converge is the red-hot U.S. housing market. The latest Freddie Mac data released Thursday showed the average 30-year mortgage rate increased 11 basis points to 3.56%, the highest since March 2020 and the fourth consecutive weekly jump. The move follows a lurch higher in 10-year Treasury yields as bond traders price in more aggressive Fed policy tightening.
While still low compared with the historical average, the highest mortgage rates in 22 months raise the prospect of slowing down what has been an unprecedented repricing in America’s residential real estate, which in turn has propelled overall wealth to new heights. Fueled by rock-bottom rates and a pandemic-inspired rush to work remotely from more spacious homes, the S&P CoreLogic Case-Shiller index of property values nationwide soared 20% in August from a year earlier, the largest jump on record. In the following months, the pace of appreciation slowed only slightly to 19.1% as of October.
The dollar figures are just as striking. The median sale price of an existing home was $353,900 as of November, up from $271,300 just two years earlier, according to data from the National Association of Realtors. The bonanza in buying new single-family houses has pushed the median price to a record $416,900, a big leap from $310,100 in April 2020, U.S. Census Bureau data show.
A few months ago, prospective homebuyers could more easily justify paying those sharply higher prices because 30-year mortgage rates had fallen back within basis points of their all-time lows, leaving monthly payments little changed from what they might have locked down in the months before the start of the pandemic. Now, for the first time, those seeking a house will face not just the highest prices in history but will have to pay a monthly rate that isn’t entirely unprecedented.
Here’s the math, using the median sale price of an existing home as a proxy for the required loan amount:
• November 2018: $257,400 price, 4.94% interest rate, $1,372 monthly payment
• January 2020: $274,500 price, 3.72% interest rate, $1,267 monthly payment
• August 2020: $310,400 price, 2.88% interest rate, $1,289 monthly payment
• August 2021: $357,700 price, 2.77% interest rate, $1,464 monthly payment
Monthly payments have been creeping higher, but not nearly as fast as home prices. The sudden spike in bond yields could change that: At the latest rate of 3.56%, when paired with the record-high median existing home price of $362,800 set in June, a buyer would have to pay $1,641 a month, a double-digit percentage increase from August.
And yet, perhaps because of concern that it will only get more costly, there’s little indication that higher payments have cooled demand. Daryl Fairweather, chief economist at Redfin, said recently that “the stage is now set for the most competitive January housing market in recorded history.” That’s partly because of strong buyer interest but also because active listings in December fell 19% from a year earlier to an all-time low.
“Buyers are pouring into the market to claim a home before mortgage rates rise further as new listings slow to a trickle,” he said in a Jan. 13 statement. “The conditions are becoming increasingly challenging for first-time homebuyers, who will have to compete against more experienced buyers who are willing to do whatever it takes to win. But I expect that by the time mortgage rates increase to 3.6%, competition will settle down quickly to levels similar to late 2018.”
I’m not as convinced that it’ll only take a few more basis points to turn the housing market into a pre-pandemic version of itself. For one thing, homebuyers likely have a different mindset when consumer prices are increasing by 7% rather than the 2% to 2.5% price growth of late 2018. Economists can quibble about whether this inflationary psychology has become entrenched or not, but survey data from both the New York Fed and the University of Michigan show longer-term inflation expectations moving firmly above the central bank’s stated 2% target.
The prospect of persistent inflation is all the more reason to purchase a house now (though, as my Bloomberg Opinion colleague Alexis Leondis wrote this week, there’s no need to panic buy). For one, the evidence of the past 30 years suggests that real estate prices will go up at least in line with other consumer goods and services, boosting the appeal of a house, or even a second or third property, as an inflation hedge. And if the Fed can’t gently guide price growth lower, it will have to consistently raise its short-term benchmark, which could push long-term mortgage rates higher as well, as it did in 2018. In other words, if the one-two punch of elevated prices and higher rates seems painful now for homebuyers, it could still get worse.
The one area where higher mortgage rates will certainly bite is demand for refinancing. We saw this a year ago: In January 2021, almost 75% of U.S. mortgage applications were for refinancing an existing loan, according to Mortgage Bankers Association data. The following month, the New York Fed said in a report that all data suggested “we are in the midst of another refinance boom.” But by early April, with the 30-year mortgage rate jumping to 3.18% from 2.65% at the start of the year, the share of refinancings had slipped to less than 60%, the lowest since January 2020. Higher rates remove the option for many homeowners to unlock an easy source of savings.
Of course, people have had ample time to refinance or take advantage of the pandemic-era level of long-term rates. And they’ve done so in large numbers. Americans collectively had $10.7 trillion of mortgage debt outstanding as of the end of September, according to New York Fed data. That’s $810 billion more than a year earlier, the sharpest 12-month increase since early 2008. The big difference from the pre-financial crisis period is that just 2% of newly originated mortgages went to subprime borrowers, much lower than the 12% average from 2003 to 2007.
The lurch higher in long-term Treasury yields could once again prove to be little more than a head-fake. But with two-year Treasury yields now above 1%, bond traders clearly see the Fed moving ahead with imminent rate increases. That alone makes it a vastly different market than a year ago, when policy makers weren’t even “talking about talking about” reducing asset purchases and it was an open question whether inflation would exceed 2%.
The other wild card for the housing market is supply, which has long been constrained. New U.S. home construction unexpectedly strengthened in December, bringing the total number of homes started in 2021 to 1.6 million. Yet finishing the job is proving difficult due to material shortages: The number of single-family homes still under construction as of December reached the highest in almost 15 years.
Like much of the U.S. economy, housing faces seemingly insatiable demand, even in the face of sharply higher prices, and there’s no easy way to quickly boost supply to find an equilibrium. The difference is that it has historically had a built-in speed bump in the form of mortgage rates. But with the Fed still months away from its first interest-rate increase and signaling it will move gradually relative to previous bouts of rampant inflation, this latest rate spike shouldn’t do much to stop the momentum.
More From Other Writers at Bloomberg Opinion:
• Rising Mortgage Rates Are No Reason to Panic Buy: Alexis Leondis
• A Shrinking U.S. Won’t Fix the Housing Crisis: Conor Sen
• Inflation Doesn’t Explain All Rising Housing Costs: Karl Smith
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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