With few exceptions most are projecting interest rates will be edging up over the next 12 months, as the Federal Reserve tapers off its four-year-plus policy of printing $1 trillion a year to buy MBS and Treasurys.
The Mortgage Bankers Association is projecting interest rates on the 10-year Treasury yield to go from 3.0% in the first quarter of 2014 to 3.3% by fourth quarter of 2014, averaging 3.2% for the year, and then creeping up to 3.5% by the last two quarters of 2015, averaging 3.4% for 2015.
Mike Fratantoni, chief economist for MBA, said he expects the Fed will taper down its quantitative easing entirely later this year.
So how will that affect mortgage applications and refis? Historically, fixed 30-year mortgage rates run about 125 bps abive Treasurys, meaning a 3.75% interest rate results in mortgage rates topping 5%.
"To the extent the Fed can clearly communicate what their path is and begin to raise short term rates very slowly," Fratantoni said, meaning the housing market will be able to adjust gradually. "As we saw in May of last year if their communication catches markets by surprise, we could see rapid jump."
Rate increases will put a damper on refis but will shift the market more to home purchases and some home equity, he said.
"Some lenders have been stronger at refis and they will have to adjust," Fratantoni said. "Others have managed to stay focused on purchases even through refi wave and are well-positioned if market shifts. We’re seeing weakness in both. What’s going to happen on the purchase side with the rise in rates and the new (QM) regulations is a bit of a puzzle."
From a high point in October 2012, mortgage applications fell 66% to a 13-year low in late December. (The next report on mortgage apps and refis comes out Jan. 15.) The refi index also hit a 5-year low and home equity applications have flat-lined. (How this affects the bigger lenders like Bank of America, J.P. Morgan, and Wells Fargo may be seen in their financials coming out this week.)
The taper, starting with a $10 billion a month cut from the $85 billion the Fed was printing, is being touted as a way to soft-land the market so that rate increases don’t stall out housing.
A lot is being wagered on the Fed’s ability to micromanage the unwinding so that rates don’t take too hard a hit, too quickly, but that’s putting a lot of faith in the central bank, which has failed to bring on a real recovery despite promises every year that this time they’ll get the formula right with somewhere between $0 and $1 trillion in stimulus bond buying.
Scotiabank's Guy Haselmann, in his report “U.S. Rates Strategy: 2014 and Beyond” takes a much dimmer view of how rates will unfold and what it will mean to the housing market.
"The FOMC wants markets to believe that they can navigate a soft landing through micro-managing the unwind process. However, investors and traders care more about the ‘final destination than the journey,’ to quote from Mohamed El-Erian, so there will become a time when the Fed tips investors from yield-seeking toward getting ‘ahead of the curve’. This point will occur during the process of the Fed lowering the accommodation needle. It will be flood markets with sellers who will be hard-pressed to find an economic bid from dealers or market- makers," Haselmann says.
"The apt analogy is a playground see-saw where investors (and Fed) have a seat firmly on the ground and risk assets dangling in the air. The Fed has started the process of tossing 10 pounds (billions of Treasuries) onto the seat in the air. Every six weeks after each meeting, another 10 pounds will be tossed on the ‘high-side,’" he says. "At some point, a few heavy investors will decide to jump-off the seat that they have been sharing with the Fed, causing the high-seat (risk assets) to come crashing down from its high perch. The Fed would like to balance the see-saw, but history suggests the chances are infinitesimal."
Haselmann says he foresees this creating a different kind of financial crisis than we have seen before.
"The 2014 crisis will likely not cause bank runs or complete dysfunction in the marketplace like it did in 2008. Today, capital can flow much more easily and quickly in a modern world, due to technology and greater investible products, so what may be bad for one country’s financial assets may be good for another’s," he writes.
How that hits housing, as Frantantoni said, is the real puzzle.
Mortgage rates started creeping up on the announcement of the taper, accompanied by a decline in existing home sales. With long-term income stagnation behind and ahead, it’s hard to see how more expensive mortgages can lead to more sales.
Further, without serious job creation – well above the anemic recovery of the past 24 months and certainly well beyond December’s tragic performance, it’s hard to see any upward pressure on housing sales, not even enough to hold things steady. The “failure to launch” problem affecting many younger potential homebuyers is also a problem that won’t be resolved without a real jobs recovery rather than the weak sauce we’ve been seeing.
When something doesn’t go up or stay steady, there’s only one other direction possible.