For a moment this week, the bond market flashed a signal that some associate with impending recessions. Home buyers need not worry just yet, according to economists.
On Tuesday, the 2-year Treasury note’s yield
briefly rose above the yield on the 10-year Treasury note, in what is called an inversion of the yield curve, a relatively rare occurence. Typically, long-term bonds like the 10-year Treasury
carry longer interest rates, or yields, than short-term bonds.
Market experts note that while yield-curve inversions are strong economic indicators that can signal the risk of a potential recession, they don’t tell investors definitively when an economic downturn is likely to come.
As Barron’s noted, an inverted yield curve is a predictor of a recession only when it remains inverted for more than a week. What’s more, a 2018 paper from the Federal Reserve Bank of San Francisco noted that the time between the inversion and subsequent recession varied between 6 and 24 months.
“So when 2-year yields rise above 10-year yields, market watchers can comfortably conclude just one thing: Investors expect interest rates and/or inflation to be higher in 2 years than in 10 years,” Barron’s noted.
“‘The expected life of a mortgage changes as interest rates change.’”
— Michael Fratantoni, chief economist at the Mortgage Bankers Association.
As for the impact to the mortgage and housing markets, it’s even less clear. “Mortgages are complicated instruments,” said Michael Fratantoni, chief economist at the Mortgage Bankers Association.
Most home loans originated in this country take the form of 30-year, fixed-rate mortgages. Lenders take their cues when it comes to setting the interest rates on these loans from the long-term bond market, among other signals. Lenders also responded to investor interest, since most mortgages are sold off. Those sales produce the liquidity needed to offer even more loans.
But the relationship between long-term debt and mortgage rates isn’t clear cut.
“A 30-year mortgage is freely payable at any time,” Fratantoni said. “So from the perspective of an investor, that means it’s complicated because the expected life of a mortgage changes as interest rates change.”
In particular, when rates fall as they did in 2020 and 2021, mortgage borrowers are likely to refinance and take out a new loan to lock in a lower interest rate, which then wipes out their old loan. Over the past few years, consequently, “mortgages were, in effect, a shorter term investment,” Fratantoni said.
Yield curve inversions used to be a bigger deal
This isn’t to say that yield-curve inversions haven’t ever had an impact on mortgage rates.
In the past, adjustable-rate mortgages, or ARMs, were a more popular product. When that was the case, these fluctuations in the bond market could have a pretty big impact on consumers’ decision-making.
The benefits of an adjustable-rate mortgage were derived from the steepness of the yield curve, said Tendayi Kapfidze, chief economist at U.S. Bank. “ARMs would have lower interest rates than the fixed mortgage rates, which were priced off of the longer end of the curve,” he said.
Today, fewer people choose to take out ARMs — a byproduct of the last housing crisis when many homeowners were burned by adjustable-rate mortgages. If those loans were still popular, however, “A flattening yield curve would essentially mean that ARMs are less attractive, and people would shift from ARMs into more fixed-rate mortgages,” Kapfidze said.
Pay attention to the Fed’s balance sheet
The yield curve’s brief inversion this week comes less than a month after the Federal Reserve moved to hike interest rates. Mortgage rates had already surged in anticipation of that rate increase, and have only continued to climb ever since.
But the Federal Reserve’s direct manipulation of interest rates isn’t the only way the central bank is influencing mortgage rates.
The Fed also has a balance sheet of assets it purchased during the first two years of the pandemic, in a bid to boost the economy. It has since stopped making those purchases, and economists expect the central bank eventually will let those assets mature off its balance sheet — meaning it wouldn’t replace any of the assets it’s holding for the foreseeable future.
Among the assets the Fed bought during that time were mortgage-backed securities. This helped to drive a great deal of liquidity into the mortgage market, which allowed lenders to cut rates to the record lows that were seen.
“It is tough to estimate just how impactful the Feds purchases of treasuries and MBS have been on longer term rates, but they’ve certainly had an impact,” Frantantoni said. Without the Fed actively in the market as a buyer of mortgage-backed securities, it will become clear in time how much influence the central bank had based on the subsequent changes in mortgage rates, he added.
At the same time, because the Fed also has sway with long-term rates, mortgage lenders may not be too worried about the yield curve’s recent signal in terms of the rates they offer.
Will mortgage availability suffer?
While an inversion of the yield curve may not have a direct impact on mortgage rates, it can prompt lenders to be stingier.
In the past, yield-curve inversions have been associated with a tightening of credit. “If it costs more to borrow short term than what you’re going to earn by lending long term, you’re going to do less lending,” said Greg McBride, chief financial analyst at Bankrate.com.
The yield curve, in this way, can be something of a “self-fulfilling prophecy” insofar as it relates to recessions, McBride said. That’s because consumers have fewer options when credit is tight, producing ripple effects throughout the economy.
But economists suggested that mortgage applicants may not see greater difficulty getting a loan as a result of this latest signal. At the start of the pandemic, mortgage lenders were quick to tighten credit due to concerns about the state of the economy. Since then, they’ve been slow to loosen it back up — and because of the strong demand they have seen from home buyers and people looking to refinance until now, they haven’t had much need to do so.
“I don’t see anybody tightening in response” to the latest recessionary signal yet, Fratantoni said. “Obviously, that could happen down the road.”