Mortgage Rates Are SOARING!! (Here's What Everyones Missing)

Mortgage rates skyrocketing. One other knock on effect we've had from yesterday's cut is that mortgage rates are surging. What does this mean for the housing market and housing prices? We are going to cruise on over to a chart of what mortgage rates are doing right now, or not necessarily right now, but I really want to focus on what they have done since the fed started cutting rates. And this is what I'm talking about. They've been skyrocketing. I wasn't really talking about the last hour or the last day, although they have gone up significantly. I'm really talking about since the fed started dropping rates. Why is this important? Well, let's think about it. The fed is dropping rates because they're a little more concerned. So they say with the labor market, then they are consumer price inflation or the economy being overheated. Let's say what we're doing right now is we're going through a thought experiment and we're saying, okay, let's see what has happened since the fed dropped rates. And let's extrapolate that forward into the future. And if this does happen again, there are no certainties, only probabilities, but if this does happen, what does that mean for the overall economy? What does that mean for housing prices? And potentially, what does that mean for other assets? Because if we have problems in the housing market, then that could force people to sell other assets on their balance sheet to compensate for the decreased perceived purchasing power. Cause again, at the end of the day, unless you sell your house, all of these gains that you have from home appreciation are just simply on paper. All right. So to be specific here, when the fed or right after the fed cut rates are, are, and we'll just go with the national average. I don't really know what the bank rate is. It doesn't matter. We'll just use the national average as a proxy or what mortgage rates are doing. Not that this is the exact number. So back in September 22, so September 22 of 2024, September 22nd, I guess I should say the national average right around 6.21%. Okay. Today we are up over 6.86. So the fed has dropped by literally 100 basis points while at the same time. And by the way, let's, let's keep this in focus too, because the fed has dropped interest rates by a hundred basis points in order to support the labor market, I E the U S economy by dropping interest rates, but yet what has happened is interest rates have actually gone up, not at the front of the curve, of course, but the long end of the curve and the long end of the curve, long rates, especially the 10 year, I would argue matter a lot more or the real economy than short-term interest rates, although short-term interest rates impact corporations and all these things, I would say still the 10 year has as more of an impact on the broad economy. Okay. So what we have to do is ask ourselves the question, why are these rates going up? Now you guys would say, George, this is obvious. It's just because of the 10 year, maybe obvious that's part of it. But I think there's more to the story than just the 10 year interest rate. Let me show you what I'm talking about. We'll go over here. This is from the Richmond fed and I wish we had an exact date. I think this probably ends at 2023, but we can see this spread increasing. Now, what is this? This is the spread between the 10 year treasury and 30 year mortgage rates. 30 year mortgage rates are the darker color, dark blue or black. And the 10 year treasury yield is the lighter blue. So you see, usually, I mean, this goes back to 1990. They are very close. I would say tied at the hip. It's very rare to see a big spread on the 30 year mortgage rate, usually tied at the hip, except since the fed has started to do what you guys know quantitative tightening, so they're reducing the size of their balance sheet. Now, if I had to, and I don't know how they're reducing the size of their balance sheet, uh, I assume they're not really selling stuff. They're just letting assets roll off their balance sheet. So I I'm just guessing here. I would assume that they tried to do this with mortgage backed securities first. If I'm the fed, that's how I do QT. I would, I would do the mortgage backed secure. I would let those roll off the balance sheet first. Why? Cause I'd be like, am I impacting the free market in mortgages more or less than I'm impacting the free market in treasuries? And to me, that's a no brainer mortgage backed securities for sure. So what happens with mortgage backed securities is there's two components as to what's driving rates, mortgage backed securities, meaning mortgages, the underlying asset. It is the 10 year, like we said, but it's also the fact that there's going to be a spread compression when the fed is in there buying because they're just buying at any price. Right? So you've got the growth and inflation expectations. Absolutely. But that spread is going to decrease theoretically, or the odds are the spread is going to decrease when the fed is out there buying because they provide this, this backstop, if you will, a little bit different with treasuries because there isn't really a default risk there, but we'll save that for topic of another video. The bottom line here is if they are selling mortgage backed securities, then you would expect the spread between the two to increase because not only are we dealing with growth and inflation expectations, but we're also dealing with the risk or the increased risk of default, right? Because now all of a sudden, if the, if it's on the fed's balance sheet, they don't care about default, but if these mortgage backed securities on the bank's balance sheet, well, guess what? They really care about default of the underlying mortgage. And therefore they are going to have to be paid for the additional risk, the risk premium on top of growth and inflation expectations where you don't have that risk premium with treasuries. So that would be my first explanation as to why we are seeing this spread increase. But I think what the overarching message is that I'm trying to communicate is just because the fed is dropping rates, doesn't mean that rates are dropping. Meaning just because they're dropping at the long end, it doesn't necessarily mean that rates at the long end are dropping as well, even if that's what the fed wants. So now what does that mean for the housing market? Well, to determine what this means going into 2025, I think we have to look at what the housing market has been doing over the past couple of months. I mean, this is something I really haven't paid too much attention to. Because there's so much going on so much, so much more going on in global macro. So this is all market driven, right? I mean, if we look at the US as a whole, let's start with that. Okay. It is true that prices have gone down slightly, but they're definitely higher than they were at this peak or one of the peaks back in 2022. So we're looking at housing in the United States in general. Bam, there you go. But it gets a little more nuanced when you get into the specific cities. I mean, as an example, my guess is Tampa is way down. Not too much, pretty much flat. Okay. Let's look at, they had Austin. I know that would be way down. Let's look at Dallas. Okay. Down slightly from this peak in 2022 to get Phoenix. I'm guessing that's down slightly. Oh, that's that's down pretty significantly. So here's our top in 2022 and there's where we are now. So Phoenix down, uh, the most so far for sure. Um, Seattle, I'm guessing is down. Yep. Seattle's down. Uh, what else here? I wish we had Austin. I'm sure you guys have probably followed the news on that, but Austin, I know is just getting shellacked at Boston. San Francisco is probably down. Oh yeah. Way down. Uh, Denver probably down. I'm guessing. Yep. Slightly Portland. I'm guessing down is Portland down and tough to see. Yeah. Portland's down slightly Las Vegas. I'm guessing is down. Yeah. Just barely. I'd call that flat. So you see my point here is when the real estate market overall. Starts to roll over. It starts with sub markets. I mean, we saw this back in 2007, 2008. I'm not saying that the housing market is going to crash to that extent, but I am saying that when, when these cycles roll over, it's very rarely that, you know, 100% of the markets crash in unison. I'm not saying that housing prices overall are going to go down nominally in 2025, but I am saying if the cycle has started, this is generally what it looks like. And also if we continue to see the fed doing quantitative tightening, we will likely continue to see the spread staying very large or actually growing, depending on how much QT they're doing with the 10 year treasury and mortgage rates. So then the question becomes what happens with the 10 year treasury. If you're looking at it through the lens of mortgage rates and how they're impacting the housing market. Well, then what you have to do, you have to say, is your base case that 10 year treasury goes down or up into 2025? This is an interesting question. I could argue both. I mean, my base case is that at the end of 2025, 25 rates will be lower on the 10 year, but I could totally see how they can go higher between now and then, because that's what they do every time in the cycle. Like I I've pointed this out many times, but I think it's it's worth repeating. If we look at, this is the 10 year treasury. If we look at this going back to 07, uh, you can see if we zoom in this timeframe right here, where the 10 year treasury, and if you can't see this, this is March of 2008, 10 year treasury was about 3.3. And it went all the way up to 4.25. So almost a hundred basis points from March 08 to June 08. So I hear a lot of people online talk about how the move in treasury, since the fed started dropping rates is totally unprecedented, and this means that the fed is losing control long into the curve and it's because all the supply coming online and the deficits and blah, blah, blah, blah. To me, that's not a very good argument because look, I mean, did this happen in sync with the fed dropping rates? No, but it's still within the cycle itself. It's very common to see the 10 year treasury go up by 70, 80, 90, a hundred basis points and keep in mind it did this during, during the recession. The United States was, that's what the shaded part represents the official recession, but remember that the NBER didn't declare the recession until December of 08 and they said, oh yeah, by the way, we've been in recession since January of 08 the last year. We just didn't tell you about it. So during this timeframe, there was no recession, right? So if you were living in markets in, let's just say, April, 2008, there was no recession at that time because the NBER hadn't announced it yet. So you're sitting there thinking, oh my gosh, look at the CPI go up because of sticky inflation. And oh my gosh, the fed is losing along into the curve. And oh my gosh, the fed is dropping rates too fast and it's over cooking. It's overheating the economy. And then the other people had been saying, well, I don't know, we might be in a recession right now. And then those, the rebuttal would be, of course, we're not in a recession. We have positive real GDP growth. Of course, we're not in a recession. Unemployment is historically very low right now. Literally the exact same arguments that you'd be getting right now. So again, my point is not to say the 10 year treasury yield is definitively without a doubt, going to go back down and we're going to have a big crash and recession, yada, yada. We could, that's probably my base case, but it doesn't mean that that's going to be the way it plays out. It could absolutely be different this time. But I am saying that just because we see the 10 year treasury yield go up by 80 basis points or whatever it's gone up by since the fed started dropping rates, it doesn't necessarily mean that's unprecedented. This is nothing we have ever seen before. And therefore we have to conclude this time is different.