The War and Mortgage Rates

The invasion of Ukraine has clouded the economic outlook (of course, the economic outlook is inconsequential compared to the ongoing human suffering in Ukraine). Fed Chair Pro Tempore Powell said today:

“The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain.”

And in the Q&A, Powell said about the March FOMC meeting:

"I am inclined to propose and support a 25 basis point rate hike"

And from BofA on uncertainty:

[W]e think it is still highly unclear how far Putin and NATO are willing to go. In particular, what will it take for the west to adopt mutually painful sanctions on Russian energy exports? How much domestic economic pain is Putin willing or able to sustain before he backs down? Would he pre-emptively curtail commodity exports to inflict economic pain on Europe?

As economic forecasters we know that relative to the pre-crisis baseline virtually all of the risks are to the downside. However, given the very foggy outlook, it is very hard to settle on an alternative baseline: we know it should be worse, but by how much?

During periods of uncertainty, there is usually a flight to quality, and, as a result, the 10-year Treasury Yield has declined sharply. The yield had been close to 2.0%, but declined to 1.7% yesterday, before increasing to 1.84% today (as of this writing).

Matthew Graham at Mortgage News Daily wrote yesterday: Biggest 2-Day Rate Drop in a Long Time as 30yr Surges Back Under 4.0%

From Friday afternoon to right now, rates have dropped more than almost any other 48-hour period in more than a decade. If we disregard the crazy market movement seen in March 2020 (and there are good reasons to do that), we'd have to go all the way back to 2011 before seeing another 48 hours that came close.

On average, effective conventional 30yr fixed rates for top tier scenarios dropped from 4.18 to 3.90 since Friday. Since rates are typically offered in .125% increments that means we've moved from a range of 4.125-4.25% to 3.875%-ish.

With the ten-year yield at 1.84%, and based on an historical relationship, 30-year rates should currently be around 3.75%. So, mortgage rates are a little higher than expected based on the ten-year yield.

The graph shows the relationship between the monthly 10-year Treasury Yield and 30-year mortgage rates from the Freddie Mac survey.

Freddie Mac has a similar graph here with a linear fit (using data since 1990).   Using their formula, 30-year rates would also be around 3.66%.

Key points:

• The invasion is leading to significant uncertainty.

• Mortgage rates haven’t fallen as fast as Treasury yields.

• The Fed is still going to raise rates in March.