First American

REconomy Podcast: What’s driving mortgage rates and where are rates headed?

In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi explain what causes mortgage rates to move up or down, and offers a mortgage rate forecast for the end of 2021.

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“Let's keep some perspective here. Prior to the global financial crisis, we never saw mortgage rates like this, we never saw Treasury yields so low, which is why the mortgage rates are largely so low. This is unprecedented territory, but a likely modest increase. And then, if the temporary inflation becomes more persistent and perceived in the markets as more permanent, you would see more upward pressure. But, basically, by the end of the year, we don't expect rates to be below 3%. We expect them to be somewhat modestly higher in the low 3 to 3.5% range. But don't hold us to it.”
– Mark Fleming, chief economist at First American


Odeta: Hello, and welcome back to another episode of the REconomy™ podcast where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark, what would you say is the question that you get asked most as a housing economist?

Mark: Oh, that's an easy one, “Where are mortgage rates going over the next four to six months?”, which, of course, is an absolutely impossible question to answer. I can guarantee you, no matter what you forecast mortgage rates to be, you will definitely be wrong when the results come out. That’s because there's a whole pile of reasons why mortgage rates change, but it gets all the way down to not just what's going to happen in the economy, but even what happens geopolitically.

Odeta: Yeah, and we know that's really difficult to forecast. And that's a really good introduction to today's topic, which is how to build a note rate pie, if you will. What are the slices? What drives the traditional 30-year, fixed mortgage rate? And maybe a good place to start is the last thing you mentioned, geopolitical events. Why would geopolitical events impact the 30-year, fixed mortgage rate?

Mark: Well, to start to build this pie…we're not talking about the mathematical number 3.14. This is a pie as in the apple pie that you eat at Thanksgiving, or pick your favorite pie flavor. For the slices of the pie, we start with the 10-year Treasury. And just keep in mind that the 30-year, fixed mortgage rate typically floats around 170, maybe as much as 200 basis points (that's two percentage points), above the 10-year Treasury. It is what we refer to as "loosely benchmarked" to that 10-year Treasury. And the reason why it's benchmarked is investors have choices. The first choice is I could invest in something that gives me a modest return at a risk-free rate, and the 10-year Treasury is basically that long-term investment that is considered to be risk free. Why is it risk free? Well, we all believe that the US government will not default on making those bond payments. So, when things go bump in the night globally, geopolitically, everyone runs – there's a flight to safety, as they say – to U.S. Treasury bonds. The more people want to buy the bonds, the lower the yield goes, which is your return on it. And it’s that yield on the Treasury bond that basically is the underpinning of the mortgage rate. So, the mortgage rate begins to go down because more and more people are buying bonds because they're afraid of the geopolitical uncertainty out there in the world.

Odeta: So, there's an inverse relationship, right? When prices of U.S. Treasury bonds go up, their yield goes down, and when the 10-year Treasury yield falls, mortgage rates follow suit. That's an easy way to remember that. Let's talk through a couple things that may impact that 10-year Treasury yield and, therefore, mortgage rates. We'll focus on two high-level things – geopolitical and economic events. And then, of course, inflation expectations. Let me give you a couple of examples of the first thing, geopolitical events, because, as Mark mentioned, sometimes there’s more at play than just economics that may impact the long end of the yield curve. One of the largest shifts in the 30-year, fixed mortgage rate since the end of the Great Recession actually occurred following the 2016 presidential election. The week after the election, we saw a flight out of bonds and into stocks that resulted in higher Treasury yields, and thus higher mortgage rates. And then, of course, we've talked about this before, we have the Brexit benefit. In the weeks following the Brexit vote in 2016 in the UK, there was a flight to safety resulting in a decline in mortgage rates. And, as a more recent economic example, at the onset of the pandemic, all of this economic uncertainty caused investors to rush to bonds, pushing the 10-year Treasury to its lowest level in 150 years. And then, of course, mortgage rates also hit a historic low. But, there's another factor…

Mark: Right. So, slice of pie number one: 10-year Treasury and the complex dynamics of economics and geopolitics that drive the 10-year Treasury up and down and, in turn influencing mortgage rates. Slice of pie number two: inflation. If you are going to invest in a 10-year Treasury bond, you would like to hopefully get at least as much return, or yield, as inflation. The safer thing to do would be to just keep capital in cash, but cash doesn't necessarily grow with inflation. So, the 10-year Treasury also acts as a hedge, if you will, against inflation. As inflation goes up, yields should also rise. That's not always true because, as we said, there are other reasons that might drive yield down for different reasons than what is going on with inflation, such as geopolitical events, but largely speaking, it's also that inflation hedge. Now, at 10-year treasuries, you know, below 1.5 or 2%, you start to ask the question, Well, you know, if inflation as we see it today is higher. Why is the 10-year Treasury yield lower? It's because of these other things. But, we can think of that inflation as upward pressure on yields. Why is it not showing up more directly today in the 10-year Treasury? That gets to this question regarding inflation, “is the inflation we see today temporary, or permanent?” And basically, because we don't see higher yields due to the higher inflation that we do observe today, the market is telling us that it believes that the inflation that we're observing at the moment is temporary, and not yet considered to be permanent.

Odeta: Thanks, Mark. That's a great explanation. Okay, so we've got the 10-year Treasury keeping mortgage rates low. Now, another slice of the pie is actually the Federal Reserve itself. Tell us a little bit more about that.

Mark: Okay, so there was this big experiment that was done in response to the global financial crisis by the Federal Reserve called "quantitative easing." I'm sure people have heard about that. Prior to the global financial crisis, the Fed would adjust monetary policy by lowering what's referred to as the Fed funds rate. The Fed funds rate is the price of borrowing on a much shorter term than 10 years. We're talking weekly, daily, monthly borrowing rates, and that's how they traditionally would influence the looseness, or tightness, as you say, of monetary policy. So, recession happens. Keynesian economics suggests that one should loosen monetary policy. The global financial crisis hits, we need to loosen it a lot. The Fed funds rate goes to zero, can't really go below that. Negative rates...we'd have to do different podcasts on that one. And so, what else do we do? Oh, well, we could intervene in the markets more directly by buying 10-year Treasuries, and also mortgage-backed securities. And keep in mind, the global financial crisis was driven by the housing market. And, actually, what happened is traditional buyers of mortgage-backed securities, got so afraid of them in the global financial crisis that nobody wanted to buy them. It was called a liquidity crisis in the mortgage industry. The Fed stepped in with quantitative easing, buying not only Treasury bonds, but became one of the largest buyers of mortgage-backed securities to basically keep the funding going into the housing finance system. But what that does is push down what we refer to as the long end of the yield curve. Long story short, the Fed intervening in buying mortgage-backed securities in particular, helps keep mortgage rates lower, even over that 10-year Treasury effectively. They squeeze that sort of 1.7 to 2 percentage point spread. Fast forward to today. And we have the pandemic-driven recession, we bring the Fed funds rate back down to zero, and start buying about $80 billion a month of Treasuries, as well as $40 billion a month in mortgage-backed securities. So, even in this round of quantitative easing, the Fed is expressly trying to push down and keep mortgage rates low.

Odeta: So, the Fed then took a page right out of its 2008 playbook when they instituted this quantitative easing program once again. And one thing to note is that recently, we've been having some pretty good jobs reports, specifically the last one in July. There's some question on whether that will prompt the Fed to taper. However, there is also this growing threat of the Delta variant and what it may do to the economy. So, this is still really a wait and see. Will the Fed decide to taper in the months to come? Will they hold off depending on the economic and health situation? But, we do know that the Fed has played a key role in keeping mortgage rates low. So, now on to the last and final slice of the pie, which actually has a couple of components in it. But, Mark, what is that last slice of the pie?

Mark: Let's call it two small slices. There are other parts to the 30-year, fixed mortgage rate that actually don't move very much. Your payment every month has to go to what's referred to as a servicer. That servicer gets paid for making sure all those monthly payments are paid. That's a very important aspect and they get paid out of that mortgage rate. So, there's a fixed cost if you will, to facilitate servicing the mortgages once they're booked. And then, most importantly, mortgages are not risk free, like a 10-year Treasury. People sometimes don't make their mortgage payments. People sometimes do go into foreclosure for one reason or another. So, the credit risk, as we call it, that risk for that obligation not being paid, has to get paid by someone. Someone has to take that risk. It's not risk free, although it's not as risky as other things. And that doesn't go away. Neither of these pieces go to zero. Those two small components add up to maybe 1-to-1.5% of the total cost of a mortgage.

Odeta: Well, there you go. That's what goes into determining your mortgage rate. But, let's circle back to that initial tough question. What does this all mean for the future of mortgage rates? You know, I had to ask you, right?

Mark: I thought I said I wasn't gonna be able to forecast them. Okay. It's really impossible, right? We don't know what's going to happen directly with the Delta variant. We don't know what may or may not happen geopolitically. Most believe that, obviously, a mortgage rate, which is currently at about 2.8% as of a week ago, will steadily rise to a shockingly high level of 3.1%. Let's keep some perspective here. Prior to the global financial crisis, we never saw mortgage rates like this, we never saw Treasury yields so low, which is why the mortgage rates are largely so low. This is unprecedented territory, but a likely modest increase. And then, if the temporary inflation becomes more persistent and perceived in the markets as more permanent, you would see more upward pressure. But, basically, by the end of the year, we don't expect rates to be below 3%. We expect them to be somewhat modestly higher in the low 3 to 3.5% range. But don't hold us to it. The only thing I can forecast reasonably well is age.

Odeta: Yeah, there you go. I can do that, too.

Mark: Exactly. But, what does this mean for the market? Well, refinances are extremely sensitive to rate increases. The going rate of refinance activity was over 700,000 in early spring. That's going to cut down by almost a half to less than half a million refinances a year on a run rate. So, it's going to be much more impactful on the refinance space and modestly impactful in terms of loss of affordability on the margin in the purchase market.

Odeta: Well, there you have it a light forecast on mortgage rates and what it could mean for the housing market. And just to recap, we discussed the mortgage rate pie, the 10-year Treasury, the Federal Reserve and fees associated with that mortgage rate, specifically servicing credit and the prepayment risks that are associated with it. Now, it's very difficult to predict where mortgage rates are headed. But, there's still quite a bit of downward pressure on the 30-year fixed mortgage rate that should keep rates near historic lows in the next couple of months. Thank you for joining us on this episode of the REconomy podcast. Be sure to subscribe on your favorite podcast platform. You can also sign up for our blog at And if you can't wait for the next episode, please follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

This transcript has been edited for clarity.