In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi break down their 2024 housing market forecast, explaining why the housing market may be poised for a rebound.
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Listen to the REconomy Podcast™ Episode 81:
“There is reason to believe that the rate lock-in effect will ease modestly this year as mortgage rates come down. And you could only imagine if they got below six, then even more people would be again ‘in the money’ and homeowners will become less anchored to that low, low rate that they got a few years ago. Homeowners who choose to sell are also often buyers too, so there should be an increase in sales activity.” – Mark Fleming, chief economist at First American
Transcript:
Odeta Kushi - Hello, and welcome to episode 81 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. So, as economists, one of our primary tasks is to forecast.
Mark Fleming -
Hi, Odeta. And I suppose that is a good thing to do now that we are in the beginning of 2024. But do you know what economist John Kenneth Galbraith said about economic forecasting?
Odeta Kushi - I don't think I do.
Mark Fleming - He said the only function of economic forecasting is to make astrology look respectable.
Odeta Kushi - Okay, well, okay, I see where he's coming from. Forecasting is tough, and oftentimes an art more than a science. I personally believe that there is a lot of value to providing forecasts because they offer a detailed perspective on future possibilities and reflect the insights and expertise of forecasters at a specific moment. They also provide an opportunity for individuals to understand the complexities involved in predicting outcomes, and maybe encourage a more thoughtful approach to anticipating future developments.
Mark Fleming - I certainly don't disagree, but that sounds like something someone would say if they were about to dive into, oh, say a podcast episode that discusses their forecasts.
Odeta Kushi - Okay, yes, you caught me, but I do stand by what I said. But, in today's episode, we're going to be discussing our outlook for 2024. Specifically, we're going to outline three reasons why the housing market will rebound this year. I should caveat that by saying that rebound is relative to the recessionary housing market of late 2022 and 2023.
Mark Fleming - I see the first trick of a good forecaster, it's all relative. A rebound in this instance, will be modest improvement over what many would argue was a pretty tough year in housing last year. And, as we've said in few recent blog posts, we expect the housing market to be not too hot, like the pandemic housing market, not too freezing cold, like the 2023 housing market, but not quite right just yet, either.
Odeta Kushi - Alright, we're looking for progress, not perfection. So I'll take it. Let's begin with reason number one. Our outlook for the housing market relies on our mortgage rate expectation. And our mortgage rate forecast is...drumroll...
Mark Fleming - Hey, wait a second. So I have to forecast the hardest one? Well orchestrated, Odeta.
Odeta Kushi - Thank you. Thank you. It's the benefit of being the moderator.
Mark Fleming - Fair enough. Okay. Mortgage rates will come down from the recent peak. Trick two of economic forecasting, say when, but not how much.
Odeta Kushi - Nice try. The people demand a number.
Mark Fleming - Okay, we'll get there. But, to your earlier point about forecasts, I think it's more important that we talk about how and why we believe mortgage rates will come down.
Odeta Kushi - That's fair, and I will do the econ-splaining for this one.
Mark Fleming - Ooh, a term from podcasts past that I believe I may have overused.
Odeta Kushi - All things in moderation. Well, the 30-year, fixed mortgage rate is loosely benchmarked to the 10-year Treasury bond, but there is a spread between the two. Since the end of the Great Recession, the 30-year fixed mortgage rate has on average remained 1.7 percentage points, or about 170 basis points higher than the 10-year Treasury bond yield. But the spread is not always consistent. It actually widens during periods of economic or geopolitical uncertainty, as has been the case in today's market. Now, we won't get into the nitty gritty details of what's driving the spread. For more on that you can check out two blog posts on our e-commerce center. We'll actually link to them in the podcast transcript. The first one is titled 'Mind the Gap Between Mortgage Rates and the 10-year Treasury yield,' and the second one is 'Will the Mortgage Rate Spread Narrow or Not? That is the Question.' Very clever titles we come up with. But the short of it is the spread reflects the risks associated with investing in mortgage-backed securities or MBS. An MBS is an investment product consisting of a pool of mortgages that are somewhat like a government bond, and investors looking for a steady return might consider them almost substitute goods. The primary difference is that MBS are riskier than government bonds. And that's really all you need to know for that.
Mark Fleming - So we have to start though by forecasting mortgage rates by looking at the yield on that benchmark government bond and what's driving that. Essentially, forecast the yield on on the 10-year Treasury. A lot of factors drive that yield up and down. But a primary driver of the increase in the yield over 2023 was inflation expectations. Inflation erodes the purchasing power of a bond's future cash flows. So the higher the current rate of inflation and, more importantly, the higher the expected future rates of inflation, the higher the yield on the 10-year as investors demand to be compensated for that inflation risk into the future.
Odeta Kushi - But inflation has made significant progress towards the Federal Reserve's 2% inflation target. So much so that the Fed itself has signaled an end to interest rate hikes. And in their December FOMC projections, they even implied three 25-basis point cuts this year.
Mark Fleming - And so what happened in December? Bond investors got really excited thinking that the threat of inflation was behind us and the yield on the 10-year Treasury came down, and of course, mortgage rates with it. If inflation continues to decelerate or economic activity slows significantly, we do expect the 10-year yield, and mortgage rates, to fall further down in 2024. But the Federal Reserve will proceed with caution and avoid cutting rates too early. So we may not see any of these benefits until the second half of the year. The path to lower mortgage rates may be a slow one this year.
Odeta Kushi - So, let's talk briefly about the second thing that you mentioned -- slower economic activity. Why would this result in lower rates?
Mark Fleming - If the economic data begins to trickle in implies a slowing economy, then recession fears begin to mount and the market begins to anticipate further expansionary Fed policy. That is basically cutting more rates, more downward pressure on the 10-year Treasury and mortgage rates to boot.
Odeta Kushi - That's a great point, Mark, and we've both discussed this. A recession is not necessarily our baseline expectation for this year.
Mark Fleming - We have discussed this and debated amongst ourselves.
Odeta Kushi - We have debated.
Mark Fleming - And it seems we're gonna bake in our baseline as rooting for a soft landing.
Odeta Kushi - Indeed, a slowing, but not shrinking economy, just as the Fed has outlined in their projections. It's likely that 2024 will bring with it a cooling labor market, slowing economy and slower inflation. This should result in lower mortgage rates, but just how low?
Mark Fleming - I'm thinking of a limbo stick right now, how low?
Odeta Kushi - I was too. Exactly.
Mark Fleming - That's indeed where the spread comes in. Part two of our forecasting. The mortgage rate, the spread between the 10-year yield and the 30-year mortgage will likely remain elevated - you alluded to that earlier on - due to reasons such as decreased demand for mortgage-backed securities. Remember, the Fed is no longer buying them at the moment. Even though more rate certainty may help to reduce the spread from its very elevated level in 2023. So lower 10-year Treasury yields combined with less extreme spreads results in...Wait for it…Here comes the number: mortgage rates around 6%, give or take. A mortgage starting with five is a welcome possibility. But don't expect pandemic-era mortgage rates anytime soon.
Odeta Kushi - All right, well, we got our number. Now I think it's time to move on to reason number two. The second reason for why the housing market will rebound this year is due to improved affordability. Now, we've already laid out the argument for lower mortgage rates. But there are two other variables in the affordability equation, income and house prices.
Mark Fleming - I think I see where we're headed with this. We mentioned earlier that the labor market is likely to continue to slow, but that slowing has been very gradual. The labor market faces a persistent labor shortage, putting upward pressure on wages and, therefore, household income. But that shortage has narrowed from the peak of 2022 and will likely continue to narrow in 2024, which means the pace of wage growth should slow down, but remain positive.
Odeta Kushi - And, as for house prices, we expect a moderation to a more sustainable pace. The housing market continues to suffer from an imbalance between housing supply and demand, which puts upward pressure on prices. And, as a result, annual nominal house price appreciation will likely continue to remain positive nationally, but maybe return closer to the historical average of 3-to-4%, as the housing market adjusts to the reality of higher than pandemic-era mortgage rates. Now, if we put it all together, what does that mean for affordability?
Mark Fleming - Modest improvement. Let's actually fast forward to December and look back to December of 2023. Something I'm sure we will actually be doing. How much do you think affordability will improve relative to December of 2023?
Odeta Kushi - Well, first we've got to make some assumptions.
Mark Fleming - Yes. We're economists, so shouldn't be a problem, right?
Odeta Kushi - That's right. Easy-peasy. So let's assume that mortgage rates fall to 6% by the end of 2024. Household income grows at the pre-pandemic historical average of 2.9%. And nominal house prices increased by 3.5% annually. Then affordability, as measured by the Real House Price Index, will improve by nearly 8%. So, a more affordable housing market will be welcome news for buyers currently sitting on the sidelines.
Mark Fleming - Yes, but here's where that 'modest, qualifier comes in. Because, even at this level, affordability will remain approximately 36% worse than it was in February of 2022, which is just before the Fed started increasing rates in the first place. Of course, maybe that February 2022 level of affordability was unsustainable to begin with. So, as we said earlier, in 2024 the housing market will not be pandemic hot, nor monetary tightening cold, but maybe not quite right either.
Odeta Kushi - Well, like I said, progress is good. So far we have lower mortgage rates and improved affordability as the drivers of the housing market rebound this year. What's the third and final forecast?
Mark Fleming - An easing of the rate lock-in effect.
Odeta Kushi - Music to my ears. That is a very important one because what the housing market needs more than anything is an increase in supply. And, as we've mentioned in previous episodes, existing-home inventory has historically made up the bulk of total home inventory. Now, Mark, for those first-time listeners, what is the rate lock-in effect?
Mark Fleming - Finally, you give me something easy to econ-splain.
Odeta Kushi - That was an easy one.
Mark Fleming - It's the disincentive for existing homeowners to sell their homes because the mortgage rate that they have on their current loan is well below what mortgage rate they could get in the market today. Recall that nearly 90% of homeowners today are locked into rates below 6%.
Odeta Kushi - So many homeowners will still be rate locked-in, even if rates fall to 6%. But, even so lower and more stable mortgage rates may encourage some existing homeowners to sell and it should bring some buyers off the sidelines. It's also important to note that homeowner equity is at a historic high and for some of those equity-rich homeowners moving and taking on a higher interest rate isn't a big deal, especially if they're moving to a less expensive home. And, finally, 42% of owned homes are owned free and clear. That means without a mortgage, and those free-and-clear homeowners may hold the key to unlocking some much-needed supply for today's housing market.
Mark Fleming - So, there is reason to believe that the rate lock-in effect will ease modestly this year as mortgage rates come down. And you could only imagine if they got below six, then even more people would be again "in the money" and homeowners will become less anchored to that low, low rate that they got a few years ago. Homeowners who choose to sell are also often buyers too, so there should be an increase in sales activity.
Odeta Kushi - Yes, a modest pickup. Modest is the word of the day here. Lower mortgage rates in 2024 will likely not be low enough to end the seller strike entirely. But, for those homeowners who do choose to sell, improved affordability for potential buyers, means there will be someone to buy it at the right price.
Mark Fleming - That's right. So, to recap our forecast, the three reasons why the housing market will rebound in '24 are lower mortgage rates, improved affordability, and an easing of the rate lock-in effect.
Odeta Kushi - Now, we wouldn't be responsible economic forecasters if we didn't reiterate that a lot could change between now and the end of the year. This outlook is rooted in the expectation that mortgage rates will slowly and steadily decline. But there are other scenarios. For example, if incoming economic data reports indicate a hotter than expected economy or hotter than expected inflation, yields could climb. But let's leave that conversation for another time.
Mark Fleming - Yeah, classic economic forecasting trick -- on the one hand, and on the other. Odeta, we were about to end the episode on a positive note for 2024. And there you go bringing it back to a downside scenario.
Odeta Kushi - Well, you know, they don't call us dismal scientists for nothing. Indeed. All right. Well, that's it for today's episode. Thank you for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. We love to hear from our listeners. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.
Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.
This transcript has been edited for clarity.
