With cooling inflation and an expected drop for mortgage rates,
will more affordable housing lead to a big spike in sales? Our
Co-Heads of Securitized Product Research take stock of the US
housing market.
----- Transcript -----
Jay Bacow: Welcome to Thoughts on the
Market. I'm Jay Bacow, co-head of Securitized Products Research
at Morgan Stanley.
James Egan: And I'm Jim Egan, the other
co-head of Securitized Products Research at Morgan Stanley.
Jay Bacow: And on this episode of the
podcast, we'll discuss our outlook for mortgage rates and the
housing market over the next 12 months.
It's Thursday, May 23rd, at 1pm in New York.
James Egan: Jay, I want to talk about
mortgage rates. From November through January, mortgage rates
decreased over 120 basis points. But then from February to May,
they've given back more than half of that decline. Where are
mortgage rates headed from here?
Jay Bacow: So, day to day, week to week,
it's hard to have a lot of conviction, a lot of things can
happen. But, over the next 12 months, we think mortgage rates are
coming down. We estimate that by summer 2025, the 30-year fixed
rate mortgage will be roughly 6.25 per cent.
James Egan: Alright, that is a significant
amount lower than about 7 per cent where we are right now. And
that's good news for affordability in the US housing market. What
gets us there?
Jay Bacow: We think inflation is going to
cool, and our economists are forecasting that the Fed is going to
cut their policy rate by 75 basis points this year and 100 basis
points next year. In fact, our economists are forecasting eight
of the G10 central banks to cut rates next year.
Now, mortgage rates are 30 year fixed rate products, so they're
based more on where the longer end of the treasury curve is than
the front end. But our rate strategists think ten year notes are
going to rally to 375 by next summer.
When you combine all of that with our expectation for secondary
mortgage rates to tighten versus treasuries, that's how we end up
with that forecast for the primary rate to rally.
James Egan: All right, I want to dig in
there. I really like how you highlighted the secondary mortgage
rates tightening versus treasuries. One thing I know that we've
both gotten a lot of questions on over the course of the past
year plus is how wide mortgages are trading versus treasuries
right now. So, what do you think drives that tightening basis?
Jay Bacow: There’s a lot of factors -- but
in end, two of them that are always going to drive things are
supply and demand. One of the interesting things is that while
housing activity has picked up, we're near the decade high in the
percentage of homes that are bought with all cash, which means
that the supply of mortgages to the market is actually not that
high.
On the demand front, we think you're going to get demand from a
broad spread of investors. We think there's been some money
manager supported inflows into the mortgage market. We think that
as the Fed cuts rates and you get the Basel III endgame
resolution, domestic banks are going to come back to the market
as they get more regulatory clarity.
And then also as the Fed cuts rates, that means that FX (foreign
exchange) hedging costs for overseas investors will be improved
and so you think Japanese life insurance companies can go back to
the market and we think there's going to be continued demand from
Chinese commercial banks. But, if you get all of this support,
then as mortgage rates come down, that should be good news on the
affordability front in the housing market, right Jim?
James Egan: Exactly. When we combine that
decrease in mortgage rates with what our US economics team is
saying will be about mid-single digit growth in nominal incomes,
we get an improvement in affordability over the next 12 months
that we've only seen a handful of times over the past 30 years.
Jay Bacow: Now this six and a quarter
forecast is certainly good news versus spot rates. It's almost
two per cent below the peaks we saw last year, but I don't really
think it solves the lock-in effect that we've discussed on this
podcast previously.
Close to 80 per cent of homeowners have a mortgage rate below 5
per cent. So, they're still out of the money versus our
expectations for our mortgage rates going next year.
James Egan: Right, and we think that's a
very important point. You made the point earlier about thinking
about supply and demand with respect to mortgage rates versus
treasuries, and we're going to talk about it here in the housing
market. We have to think about affordability improvement in terms
of both that supply and demand piece.
If we look back towards the start of this year, I'd say that
demand increased a little bit faster, a little bit stronger than
we thought. Typically, when you see sharp improvements in
affordability, it doesn't always lead to immediate increases in
sales volumes. However, what we saw from November to January
seemed to be a little bit quicker to stir animal spirits, perhaps
because of how healthy this improvement in affordability was.
Home prices were still climbing. Mortgage rates weren't even
coming down because the Fed was cutting; it was because of market
expectations for future fed cuts in a soft landing environment.
But on the supply side, while we expect for sale listing volumes
to increase as rates come down, they aren't going to race higher
because of that lock-in dynamic that you just described.
Jay Bacow: So, Jim, you think more people
will list their homes; but what will actually happen to sales
volumes? Will people buy them?
James Egan: Right. So, I think we have to
delineate between existing home sales and new home sales here.
Yes, we think existing listings are going to increase on the
margins. New home inventory has already increased.
Historically, new homes make up about 10 to 20 per cent of the
for-sale inventory on a monthly basis. Right now, they're between
30 and 35 per cent, and that's been the case for a little while.
So, when we think about our forecasts for sales volumes, we're
confident that new home sales will increase more than existing
home sales. And that that growth in new home sales will spur
single unit starts to increase more than both of them.
Our specific spot forecasts, 10 per cent growth in new home
sales, 5 per cent growth in existing home sales, with single unit
starts edging out a double digit return of about 15 per cent
growth.
Jay Bacow: Do you have specific spot
forecasts for home prices as well?
James Egan: We do. As supply increases, the
pace of home price growth should slow from where it is right now.
It's been accelerating for the past several months, but the
absolute level of supply is still pretty tight. We're at 3.8
months of supply as we're recording this podcast. Any reading
below 6 is really associated with home price growth, not just
today, but at least over the course of the next 6 months -- and
we're well below 6 months of inventory.
Right now, home prices are growing at about 6.5 per cent. We
think they're growing to slow to about 2 per cent by the end of
2024, before accelerating to 3 per cent in 2025. So, while
growing inventory leads to deceleration, tight inventory keeps
home price appreciation positive.
Jay Bacow: Alright so, home sale activity
is going to pick up. It's going to be led by starts, which we
think will be up 15 percent and more new home sales than existing
home sales. There’s new home sales up 10 per cent. Home prices we
now think will end the year positive; up 2 per cent in 2024 and
up 3 per cent in 2025.
Jim, always a pleasure talking.
James Egan: Great speaking with you, Jay.
Jay Bacow: And thank you for listening. If
you enjoy Thoughts on the Market, please leave us a review
wherever you listen and share the podcast with a friend or
colleague today.
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