The housing market correction takes an unexpected turn

The Federal Reserve has a simple manual for fighting inflation. It goes like this: continue to put upward pressure on interest rates until business and consumer spending throughout the economy weakens and inflation recedes

Historically speaking, the Fed's inflation handbook always delivers a particularly hard blow to the US housing market. When it comes to real estate transactions, monthly payments are everything. And when mortgage rates rise-which happens as soon as the Fed goes after inflation-those payments increase for new borrowers. This explains why so that mortgage rates have risen this spring, the real estate market has fallen into a real estate slump.

But that housing correction can lose a little bit of strength soon.

Last week, mortgage rates dropped rapidly. On Tuesday, the average 30-year fixed mortgage rate was at 5.05%, down from June, when mortgage rates peaked at 6.28%. These falling mortgage rates give immediate relief to home buyers who were in the corner. If a borrower in June take out a $ 500,000 mortgage at a rate of 6,28%, he would pay $ 3,088 monthly in principal and interest. At a rate of 5,05%this payment would only be US$ 2,699. Over the 30-year loan, this represents a savings of US$ 140,000.

What is happening? As we that weakened economic data comes inthe financial markets are pricing a recession in 2023. This is putting downward pressure on mortgage rates.

"The bond market is pricing in a high probability of a recession next year, and that the slowdown will lead the Fed to reverse course and cut [federal funds] rates."

said Mark Zandi, chief economist at Moody's Analytics, Fortune.

Although the Fed does not directly set mortgage rates, its policies affect the way financial markets price so much the yield of the 10-year Treasury about mortgage rates.

In anticipation of an increase in the Federal Funds rate and monetary tightening, financial markets are raising both the 10-year Treasury yield and mortgage rates.

In anticipation of a reduction in the federal funds rate and monetary easing, financial markets price both the 10-year Treasury yield and mortgage rates. The latter is what we are now seeing in the financial markets.

"The bottom line is that the recent decline in mortgage rates will help at the margin, but the housing market will remain under pressure with mortgage rates at 5% (fewer sales, slowing home price growth)."

writes Bill McBride, author of the book Economics Blog Calculated Risk, in its Tuesday bulletin.

The reason? Even with the one percentage point drop in mortgage rates, housing affordability remains historically low.

"If you include rising house prices, payments increase by more than 50% year over year on the same house," McBride writes.

There is another reason why real estate bulls should not get too confident: if recession fears - which are helping to reduce mortgage rates - are correct, this would cause some further weakening in the sector. If someone is afraid of losing their job, they will not enter the real estate market.

"While lower rates alone are positive for the housing market, this is not the case when accompanied by a recession and rapidly rising unemployment."

said Zandi to Fortune.

Monthly payment of principal and interest on a new $ 500,000 mortgage

The average 30-year fixed mortgage rate fell from 6.28% to 5.05% in the last two months

Where will the mortgage rates go from here?

Bank of America Researchers believe that there is a chance that the yield on the 10-year Treasury will fall from 2.7 to 2.0% in the next 12 months.

This could cause mortgage rates to drop to between 4% and 4.5%. (The path of mortgage rates correlates closely with the path of the 10-year Treasury yield.)

But there is one big wild card: the Federal Reserve.

The Fed clearly wants to slow down the housing market. O Pandemic real estate boom which house prices went up 42% e homebuilding reached a 16-year high- is among the drivers of sky-high inflation. Reduced home sales and a decline in home construction should ease the supply of housing in the US. We are already seeing this: the house price adjustment is translating into reduced demand for everything from wood to cabinets and windows.

But if mortgage rates fall too quickly, a recovering housing market could get in the way of the Fed's fight against inflation. If that happens, the Fed has more than enough monetary "firepower" to put further pressure on mortgage rates.

"Whether we are technically in recession or not, that doesn't change my analysis. I am focused on the inflation data... And so far, inflation continues to surprise us on the upside."

said Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, to CBS on Sunday.

"We are committed to reducing inflation. , and we will do what we need to do."

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