US housing market needs more Fed rate cuts to boost supply: Fitch

September 23, 2024 (MLN): Federal Reserve rate cuts will relieve pressures on the U.S. housing market, but mortgage rates are unlikely to fall below 5% before 2027, Fitch Ratings says.

The 30-year fixed mortgage rate and the 10-year Treasury yield have already priced in the 50bp Fed rate cut, and even with further cuts, declines in the 30-year mortgage rate to around 5% are contingent on the spread over 10-year Treasuries reverting to the 10-year pre-pandemic average of 1.8pp.

The 10-year yield has less room to decline following the rate cut after declines this summer in anticipation of easing monetary policy.

Fitch expects the 10-year yield will not fall much further than its current level of around 3.7% to end 2026 at 3.5%. A 3.5% 10-year Treasury yield plus the historical average spread of 1.8pp results in a 5.20% mortgage rate.

The spread between the 30-year mortgage rate and the 10-year Treasury yield has been elevated relative to the historical average since the Fed began raising policy rates in March 2022, reflecting increased mortgage prepayment risk as well as the Fed decreasing its holdings of MBS.

The spread neared 3.0% in November 2023, when the average 30-year fixed mortgage rate was at a cycle high of 7.8%, and has compressed slightly, averaging 2.6pp since January 2024.

Housing demand, as measured by homes sold above list price and the average sale-to-list price, has softened since August 2023 but remains above long-term averages.

A further decline in mortgage rates will help improve affordability and support demand, but low inventory will likely constrain home sales until rates move closer to 5.00%. Around 24% of outstanding mortgages have rates above 5%.

As mortgage rates near 5%, likely in 2026, homeowners with these higher rate mortgages as well as those with rates between 4% and 5%, about 19% of outstanding mortgages, should be more willing to sell their homes and assume a new mortgage.

Total U.S. inventory has broadly increased this year but is still below pre-pandemic levels, driven by a 27% drop in existing home supply since February 2020.

While new home inventory has grown by 29% since the start of the pandemic, improving the supply of existing homes, which are approximately 80% housing sales, is necessary to improve prices and housing market activity.

Mortgage originators are already benefitting from increased volumes as refinancing activity has incrementally picked up with declining mortgage rates.

Homeowners with mortgage rates greater than 6.00% are 14% of outstanding mortgages, or approximately $1.5 trillion-$2tr, and this segment of the market is in play for refinancing as the average 30-year rate approaches 6%.

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