Our Co-Heads of Securitized Product Research Jay Bacow and James
Egan discuss the outlook for mortgage rates and the U.S. housing
market in 2026.
Read more insights from Morgan Stanley.
----- Transcript -----
Jay Bacow: Jim, why did the cranberry turn
red?
James Egan: Please enlighten me.
Jay Bacow: Because it saw the turkey
dressing.
Jay Bacow: I hope everybody had a good
Thanksgiving. 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.
Today we're here to talk about our views from mortgage rates in
2026 and how that flows through to our U.S. housing outlook.
It's Monday, December 1st at 11:30am in New York.
Now, Jay, as we all get over our turkey induced naps over the
weekend, how are we thinking about mortgage rates evolving in
2026?
Jay Bacow: Well, as you and I discussed
previously on this podcast, the Fed cutting rates in and of
itself doesn't actually cause the 30-year fixed rate mortgage to
come down. However, our rate strategists’ forecast for lower
rates in the front end should be helpful to where the primary
rate ends up this year. And we would also expect some compression
between primary mortgage rates and Treasury rates given our
bullish outlook for the mortgage asset class. So, our expectation
is that the 30-year fixed rate ends 2026 around 5.75 percent.
James Egan: Alright, if we get to 5.75,
maybe a little bit lower than that in the middle of next year,
that's enough to send affordability into a healthier place. But
that's a relative term. Affordability is still going to be under
pressure, but it will have improved. And it will have improved at
a pretty healthy amount from where we were in the fourth quarter
of 2023, which was multi-decade levels of challenged.
Jay Bacow: All right, Jim, so clearly the
mortgage rate coming down does make homes more affordable, but is
it enough to cause more homes to actually transact?
James Egan: So, the answer is yes, but it's
going to be a ‘Yes, but’ answer from that perspective. We do
think that transaction volumes are going to increase. But to put
into context where we sit from a housing market perspective – we
already saw a healthy increase in affordability from the fourth
quarter of [20]23 through the end of 2024, right?
But if we put that affordability improvement in context, we've
seen that about 10 times over the past 40 years. The only times
where sales responded more tepidly than they just did in 2025 –
were in 2009, the teeth of the Great Financial Crisis; and in
2020, when the market really slowed down in the immediate
aftermath of COVID.
The lock-in effect is still playing a very big role. We do think
that this sustained marginal improvement and affordability will
help purchase volumes. But this is not what's going to get us to
kind of escape velocity. We're calling for about a 3 percent
growth in purchase volumes next year.
Jay Bacow: Alright. Now, you mentioned this
a little bit already, but if there's less lock-in because the
mortgage rate has come down, will more people be willing to list
their homes for sale? Are we going to get more inventory on the
market?
James Egan: I think that's the other piece
of how we're thinking about housing moving forward. Any
improvement we get in affordability from lower mortgage rates is
going to be paired with increasing inventory volumes. We've
already seen that. Listed inventories are up roughly 30 percent
from historic lows in 2023.
They're still 20 percent worth below where they were in 2019. So,
we're not talking about oversupply at this point. But that
increase in listed inventories without a contemporaneous increase
in demand is weighed on the pace of home price growth. We started
this year at +4 percent nationally. We're below +1.5 percent. We
think that any growth and demand will come coincident with the
growth in listing volumes.
That's going to keep home price appreciation under control. We're
only calling for 2 percent growth in HPA next year, 3 percent out
in 2027. But the high level thought here is that the housing
market is well supported at these levels. Difficult to see big
decreases in sales volumes or prices next year. But also going to
be difficult to really achieve any more material growth in this
low single digits we're calling for.
But Jay, as you and I are talking about this outlook with market
participants, one question that gets brought up frequently is
what else can the administration do, especially on the
affordability side, to help with instigating more housing
activity.
Jay Bacow: In order to really help
affordability, given the challenges that you've discussed around
the supply and demand issues; then the other aspect of that is
just what is the mortgage rate? And if they were to do things
that would cause the mortgage rate to come down, that would be
helpful.
Now, the Fed already has made an announcement that they're going
to continue mortgage runoff from their balance sheet. If they
ended mortgage runoff, that would've helped. But that window
seems to have passed. There's been some discussion from the
administration around new types of programs. In particular, there
was a lot of headlines around a 50-year program. A 50-year
amortization schedule would likely result in a material drop in
the monthly payment that the homeowner would make – which would
help.
However, the total interest payments for that homeowner,
depending on exactly where this hypothetical 50-year mortgage
rate would price, are probably about double over the life of the
loan relative to a 30-year fixed rate mortgage. So, we're not
really sure that this product would see a huge amount of upkeep.
There's also some technical challenges around whether it meets
the definition of a qualified mortgage and some other in the
weeds discussions.
James Egan: What about all the discussion
we're hearing around assumability of mortgages, portability of
mortgages? Is there anything there?
Jay Bacow: Based on our understanding of
contract law, which I have to confess is limited as I am not a
lawyer, we don't think you can retroactively make mortgages
portable or assumable that were not already portable or
assumable.
So, you can make new mortgages portable and assumable. Portable
as a reminder means that if you have a mortgage, you take it with
you to your new house, and assumable means that the mortgage
stays with the house. If you sell it to somebody else, they get
that mortgage. But realistically, we think this would have to be
a new product. And because it would be a new product with new
benefits to the homeowner, it would actually probably cause their
mortgage rate to be higher, not lower.
James Egan: I guess one last question.
We're talking about affordability and we're addressing it through
interest rates being lower, we’re addressing it through the
potential for new products to be put out there, even if there are
some challenges around that piece of it. But what about just
demand for mortgages themselves? You said the Fed might not be a
buyer going forward, but are there other pockets of demand for
mortgages that could help bring down mortgage rates?
Jay Bacow: Sure. So, we expect the GSEs to
grow their portfolio next year, that would certainly be helpful.
On the margin, we expect them to buy about a little less than a
third of the net issuance that comes to the market. We also think
that domestic banks could come back to the market and they could
help bring the mortgage rates lower. But these changes are going
to help mortgage rates by, in the context of maybe an eighth of a
point to a quarter of a point at most. It's not a panacea,
unfortunately.
James Egan: Alright. So, we expect a little
bit of an improvement in mortgage rates, a little bit of
affordability improvement next year. That should lead to growth
in purchase volumes, and I think it will lead to a little bit of
growth in home prices. But the housing market is well supported
range bound here.
Jay Bacow: Jim, pleasure talking to you.
And to all our regular listeners, thank you for adding Thoughts
on the Market to your playlist.
James Egan: Let us know what you think
wherever you get this podcast and share Thoughts on the Market
with a friend or colleague today.
Jay Bacow: And as my kids would say, go
smash that subscribe button.
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