The Housing Market and Rate Sensitivity: What Happens Next?

The Housing Market and Rate Sensitivity: What Happens Next?

On Wednesday, September 18th, the Federal Reserve is expected to cut interest rates by 25 to 50 basis points (bps). In anticipation of rate cuts and a shift in Fed policy, longer-term Treasury Yields and mortgage rates have already moved lower in the bond market. On paper, lower rates should stimulate demand for home purchases and unlock a greater supply of existing homes for sale. But as we’ve seen over the past few years, supply and demand dynamics in the housing market might not be so straightforward.

The Lock-In Effect

In a prior post (“Fool Me Twice”), I discussed the unique dynamics of today’s housing market—where homeowners are “locked in” to historically low mortgage rates, suppressing the supply of existing homes for sale. Why sell your home with a 3.5% mortgage only to take on a new 7% loan?

In some ways, the housing cycle has turned upside down. While the Fed’s aggressive rate hikes aimed to cool demand and inflation, they inadvertently froze the existing housing supply, which meant the cost of home ownership (a combination of price plus the cost to finance a purchase) remained elevated.

With rates expected to fall in the coming months, it’s tempting to think this will reignite both demand and supply for existing home sales. A simple model suggests that falling benchmark 10-Year Yields, coupled with tightening mortgage spreads, should make homeownership or relocation for existing homeowners more attractive. And as buyers take advantage of lower rates, sellers—who’ve been sitting on the sidelines—may finally feel confident enough to list their homes. But is it that easy?

 

The Wait-and-See Conundrum

There’s another possibility worth considering: Lower rates – or the expectation thereof – may delay demand, not accelerate it. As homeowners and prospective buyers adjust their expectations to an environment of falling rates, they might enter “wait-and-see” mode. Why rush into a 6% mortgage if you think rates will be lower in a few months?

The chart below from the team at 3Fourteen Research gets at the heart of this conundrum by plotting the relationship between mortgage applications and the level of mortgage rates, typically an inverse relationship:

The psychology here is tricky. Falling rates ought to make the housing affordability equation more favorable for prospective buyers (who may also be sellers in a two-sided transaction). But in today’s market, after years of erratic shifts in both rates and housing prices, buyers may be cautious. The expectation of further rate cuts could encourage procrastination, stretching out the cycle as both buyers and sellers sit tight on the sidelines in hopes of getting even lower rates down the road.

The Broader Economic Picture

The implication of a frozen housing market is that it could be either the trigger for, or a sign of, broader economic weakness. If demand for housing doesn’t pick up in a falling rate environment, it could be particularly troubling for the home construction industry, one of the few bright spots in the housing market over the past few years. A softer labor market for construction could spill over into other areas of the economy, or – in a classic chicken versus the egg dilemma – it could be a sign that other areas of the economy have already weakened.

In other words, lower rates may not be enough to fully revive housing demand or unlock the supply of existing homes for sale. To make matters even more complicated, if inflation remains sticky and the Fed signals a more prolonged rate-cutting cycle, the waiting game for home buyers could stretch out even further.

Final Thoughts

While the textbook model of supply and demand suggests that lower rates will drive housing demand and unlock existing supply, we should remain skeptical of any one-dimensional narrative. The dynamics of today’s housing market are far from typical, and the psychological impact of rate expectations could dampen or delay any surge in activity. As always, the market will continue to surprise us, and no two housing cycles are alike.

 

Advisory Services offered through Peak Asset Management, LLC, an SEC registered investment advisor. The opinions expressed and material provided are for general information, and they should not be considered a solicitation for the purchase or sale of any security. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. This content is developed from sources believed to be providing accurate information and may have been developed and produced by a third party to provide information on a topic that may be of interest. This third party is not affiliated with Peak Asset Management.  It is not our intention to state or imply in any manner that past results are an indication of future performance. Copyright © 2024 Peak Asset Management