The debt limit fight between the Republican-controlled House of Representatives and President Joe Biden’s White House is adding pressure to a shrinking mortgage market.
Amid the rising risk of government default, mortgage rates increased to the highest level in two months last week, and its spread to the Treasury bonds widened above the historical average.
Freddie Mac‘s Primary Mortgage Market Survey showed the 30-year fixed-rate mortgage averaged 6.57% as of May 25, up 18 basis points from last week’s 6.39%. The same rate averaged 5.10% a year ago at this time.
Other indexes, however, showed rates even higher.
The 30-year fixed rate for conventional loans was 7.03% at Mortgage News Daily as of Thursday morning. HousingWire’s Mortgage Rates Center had Optimal Blue’s 30-year fixed rate for conventional loans at 6.73% on Wednesday, up from 6.50% the previous Wednesday.
“Although the probability of a default remains low, even the fears and panic related to a potential government default could cause creditors to ask for higher interest rates from the U.S. Treasury, resulting in a significant increase in various borrowing costs, including mortgages,” Jiayi Xu, an economist at Realtor.com, said in a statement.
Xu added, “Resolving the debt impasse sooner rather than later would mitigate potential adverse effects on the housing market, which is already contending with high prices and elevated mortgage rates.”
George Ratiu, a chief economist at Keeping Current Matters, agrees that the likelihood of default is “virtually nil” but adds to existing risks, which are reflected in the spreads between the 10-year Treasury and the Freddie Mac 30-year mortgage rate.
The spreads were at 172 bps on average between 1971 and 2023, but reached 278 bps from January to May 2023. The only times the spreads exceeded 300 bps were during periods of high inflation or economic volatility, such as in the early 1980s or the Great Financial Crisis of 2008-09.
“Investors are reacting to the political brinkmanship over the debt limit, which is injecting another shot of uncertainty into the financial outlook,” Ratiu said in a statement. “Mortgage bond investors are looking for higher yields in exchange for the increase in perceived risk.”
A debt ceiling agreement, however, may not mean less economic volatility. The U.S. can still face a downgrade to its long-term debt. On Wednesday, Fitch Ratings placed the U.S. “AAA” rating on a negative watch.
“Fitch still expects a resolution to the debt limit before the x-date. However, we believe risks have risen that the debt limit will not be raised or suspended before the x-date and consequently that the government could begin to miss payments on some of its obligations,” the rating agency wrote.
Fed’s next steps
Another source of uncertainty is the Federal Reserve‘s (Fed) monetary policy. Officials will meet on June 13-14 to decide on the new federal funds rate. And, despite mortgage industry experts believing the Fed is likely to stop its tightening monetary policy, a still-resilient economy brings the possibility of another rate increase.
“An additional area of focus revolves around the release of the Federal Reserve’s minutes from its May meeting: although investors anticipate a pause at the upcoming meeting after ten consecutive rate hikes, the minutes revealed a sense of uncertainty regarding the future direction of monetary policy,” Xu said.
Ratiu added that the Fed’s willingness to take a break from its monetary tightening at the June meeting, as expressed by Chair Jerome Powell, may be a welcome reprieve for financial markets.
“However, the Fed has its eyes clearly fixed on the inflation double-peaks from the late 1970s and early 1980s, seeking to avoid the same mistake,” Ratiu said. “For people who assume that the central bank is done pushing the policy rate higher, prices riding an upward trajectory may provide a counterpoint.”
According to Sam Khater, Freddie Mac’s chief economist, the U.S. economy is showing continued resilience which, combined with debt ceiling concerns, led to higher mortgage rates this week.
“Dampened affordability remains an issue for interested homebuyers and homeowners seem unwilling to lose their low rate and put their home on the market,” Khater said in a statement. “If this predicament continues to limit supply, it could open up an opportunity for builders to help address the country’s housing shortage.”