Submitted by Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
There was a big move in the bond markets last week, with Treasury bonds rallying for their largest gain in almost four years. The result was a big drop in the yield on the 10-year Treasury bond, falling below 5% for the first time since the last week of September. The big move was short-lived, however, with yields moving back up to almost 5% the next day.
So much can change in one month. As recently as early September, the 10-year yield was under 5%, and mortgage rates were well under 7%. Prior to the Iran War, 10-year yields were under 4%, and mortgage rates were trending downward toward 6%. For mortgage rates to decline again, the 10-year yield must decline. That’s one of the purported reasons the Treasury Secretary pursued a bond-buying scheme back in September, to boost prices and reduce yields. That effect ultimately proved to be minimal, though.
The drop in 10-year yields was driven in part by fears surrounding the whole AI buildout, and whether revenues generated from AI will be sufficient to justify the massive amounts of debt being incurred to finance AI infrastructure. This contributed to a rotation from technology stocks to more traditional blue-chip stocks, some of which comprise the Dow Jones Industrial Average. While the NASDAQ cratered on Thursday, stocks like Procter & Gamble, Johnson & Johnson, and Coca-Cola all finished higher. After investors rotated out of technology, the NASDAQ dropped 2.6%, but the Dow edged up 0.03%. For the week, the NASDAQ was down 0.7%, while the Dow was up 0.4%.
A declining 10-year yield would push mortgage rates down from the recent high of 7.5%. This would come as welcome news for the ailing housing sector. Recent reports show a big drop in pending home sales, putting the index at the lowest level since 2001, the start of the series. That means signed contracts for existing home sales were weaker than in any month in the past 25 years. Housing starts also declined in September, down 5.2%. All this is not making homebuilders more optimistic either, with the National Association of Home Builders (NAHB) Index at its lowest level since 2012. In this same report, it was indicated that 43% of builders are cutting prices. No wonder builder optimism is down.
Mortgage rates above 7% are having somewhat of a chilling effect on the residential real estate market across Indiana and Southern Indiana. Across Indiana, pending home sales are already down 10% from last year. For Southern Indiana, pending home sales are down 15% in September, and closings have also declined from last year.
Higher mortgage rates will also intensify the “lock-in” effect that originated with the ultra-low mortgage rates of 2021. Homeowners who secured a mortgage under 3% have little interest in selling, either downsize or upsize. The lock-in effect, which had eased somewhat, limits the supply of homes on the market, putting upward pressure on home prices.
So, while listings are up from the low point of 2021, statewide listings are only about 65% of the level from 10 years ago. While mortgage rates are higher, we have not seen any significant erosion in home prices due to the limited supply of housing. The median home price for Indiana is now up to $275,000, an increase of 31% from five years ago and 4% from last year. Southern Indiana’s median home price is slightly lower at $272,500, but also up 4% from last year.
Back in February of this year, the 30-year mortgage rate approached 6%. The 10-year yield had fallen below 4%, and this was about to push mortgage rates under the psychological 6% threshold. Since then, inflation has reemerged, pushing yields above 5%, and mortgage rates are now closer to 7.5%.
A growth scare, like the one that occurred with the AI buildout, would drive yields lower, and along with them, mortgage rates. This, however, is doubtful. While there are potential dark clouds on the horizon, the economy continues to run strong, as evidenced by above-trend GDP growth.
Another route to lower mortgage rates is tied to inflation. Lower inflation would put downward pressure on 10-year yields, and mortgage rates would likely follow. While headline inflation remains elevated at 3.7%, this is due primarily to the Iran War and its impact on oil prices. Implied inflation rates five years out are also just above 2%, suggesting that inflation will be contained.
If the war comes to an end soon, and the price of oil declines with it, both headline and core inflation could trend downward. The ultimate effect would be lower mortgage rates, but several months out.
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