High Mortgage Rates and a Stuck Housing Market

James Egan · Morgan Stanley

At 7.5% mortgage rates, housing activity stays stuck at multi-decade lows with little chance of an upside breakout.

The 7.5% mortgage rate raised the median-home monthly payment over $325, up about 17% since February. Leading demand indicators are softening: pending home sales are down 3-5% year over year and September purchase applications down about 10%. Sales are up only about 2% year to date off a very low base. If rates stay at these levels, the chance of an activity escape to the upside keeps shrinking and the market stays range-bound at the lowest turnover in forty years. He avoids calling it demand destruction.

“We think... with rates at these levels if we maintain these levels... the probability or any real ability of the market to escape to the upside from an activity perspective... keeps coming down, and we're going to be stuck in this turnover, very range bound, lowest level of sales as a percentage of the housing market in forty years.”at 4:21

James Egan · Morgan Stanley

Home price appreciation of about 2% is sustainable through year-end despite softer demand, because the lock-in effect restricts supply.

Softer demand would normally pressure prices, but the lock-in effect has slowed growth in existing listings materially. As a result, home price appreciation accelerated from about 0.7-0.8% four months ago to 1.9% in the latest data. He expects roughly 2% to be sustainable for the rest of the year.

“We think that that level is kind of sustainable here, and we're gonna be between, like, roughly 2% give or take for the remainder of this year.”at 5:57

Jay Bacow · Morgan Stanley

Rising ARM uptake is a small but helpful positive for affordability challenges.

ARMs rose from a little over 15% to a little over 16% of issuance, first half year over year. A 1-point shift is small, but on over $2 trillion of expected annual issuance it helps at the margin. More ARM uptake would likely be a modest positive solution to affordability challenges.

“1% increase is not a huge number by itself, but when we're talking about a little over $2,000,000,000,000 of expected issuance in the course of the year across the entire mortgage market, this does help on the margin.”at 6:42

James Egan · Morgan Stanley

Short-reset ARMs are the risky product; 5/1, 7/1 and 10/1 ARMs perform like fixed-rate loans, so ARM expansion can be responsible.

Controlling for credit score, loan-to-value and debt-to-income, 7/1 and 10/1 ARMs perform much like fixed-rate mortgages. Only short-reset affordability products with 24-36 month fixed periods historically showed much higher default rates. Current ARM growth is in the 5/1, 7/1 and 10/1 space, so it need not signal a repeat of the financial-crisis lending-standards problem. Mortgage product can be expanded into ARMs responsibly.

“The ARM growth that we're seeing is in the five one, seven one, ten one space. Those have historically, again, controlling for borrower performance, performed like fixed rate mortgages. And so we think that you can expand mortgage product into arms and do it responsibly.”at 8:13

Jay Bacow · Morgan Stanley

Convexity-hedging feedback pushing Treasury yields higher isn't a major mechanism at current rate levels.

Higher Treasury yields lengthen mortgage average life, which can push mortgage investors to sell Treasuries or mortgages to restore duration and drive yields higher still. But average homeowner mortgage rates are about 4.5%, roughly 300 basis points out of the money. Prepayment speeds are therefore already insensitive, so the feedback loop matters less than when rates were lower. Current yield drivers are inflation expectations and geopolitical concerns.

“We don't think there's a huge mechanism of that going through at this rate level. The average mortgage rate that homeowners have in America is almost exactly four and a half percent... they're 300 basis points out of the money.”at 2:26