Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Housing Market Is Mispricing Mortgage Rates
Transcript
- Lucas: The ten-year Treasury yield is sitting at 4.66 percent this morning — up almost two percent in just the last five days — and yet the average thirty-year fixed mortgage rate is barely above 6.7 percent. That spread is about two hundred basis points, which is actually below the historical average of roughly two-fifty. So the bond market is screaming one thing, and the mortgage market is whispering something else. Luna: And that gap feels like it should be wider, given how aggressive the Fed has been. The effective Fed funds rate is still at 3.63 percent, and the rate on reserve balances is 3.65 percent. So why aren't mortgage rates repricing faster? Lucas: Part of the answer is that mortgage lenders are competing hard for a shrinking pool of buyers. The volume of existing home sales is running at around four million annualised — that's down about thirty percent from the peak in 2021. So banks and non-bank lenders are eating some of the spread to keep origination volume alive. They're basically subsidising the borrower with thinner margins. Luna: Right, and that's the kind of thing that works until it doesn't. But let's talk about the homebuilders — they're doing something even more aggressive. They're offering permanent rate buy-downs, sometimes buying the rate down by a full percentage point for the life of the loan. Lucas: Exactly. Builders like Lennar and Pulte have been using these incentives aggressively. In their most recent quarterly filings, they reported spending roughly ten thousand dollars per home on rate buy-downs and closing cost assistance. That's a direct hit to their margins, but it allows them to keep the headline price high while making the monthly payment palatable. Luna: And that's the key — the sticker price isn't really reflecting what buyers are paying. If you bake in the buy-down, the effective mortgage rate might be closer to 5.7 percent for the first few years. That's a massive subsidy, and it's inflating the transaction data. Lucas: We deliberately don't run ads on these episodes — no sponsor breaks, no commercial interruptions. And we want to keep it that way. If you find this kind of analysis useful, a small gesture at buy me a coffee dot com slash fexingo helps us stay independent and ad-free. Luna: Yeah, it's a direct way to support the show without any third-party noise. We appreciate everyone who chips in. Lucas: So back to the buy-downs — the CPI data for June came in at 332.6, which is actually down slightly from the prior month, and core CPI is basically flat at 336.1. That suggests shelter costs, which are a big component, are still sticky. The official measure of owners' equivalent rent is still rising at about four percent annually, even though market rents in places like Austin and Phoenix have been falling. Luna: That's the classic lag effect. The CPI captures what people are actually paying, including those who signed leases a year ago. So even if new leases are cheaper, the index takes time to catch up. The real-time data from Zillow and Apartment List shows asking rents down about one percent year-over-year nationally. Lucas: Right. And that divergence is important for the Fed. The Fed looks at core PCE, not CPI, but PCE also weights shelter slightly differently. Core PCE is at 130.1 as of May, still ticking up. So the inflation picture is muddled — goods inflation is cooling, services inflation is sticky, and shelter is the big wildcard. Luna: And then you layer in the tariff story. The administration just announced generic drug tariffs starting in 2028, which is two years away. That's a headwind for disinflation, but it's not immediate. The bigger near-term issue might be the import price data from last week — Chinese import prices hit their highest since 2008. Lucas: That's a big deal. If the cost of goods from China is rising, that eventually feeds through to consumer prices. But right now, the housing market is the most distorted part of the economy. New home sales are running at about seven hundred thousand annualised, which is below the historical average of around eight hundred thousand. But the mix is shifting — more new homes, fewer existing homes, because existing homeowners are locked into their 3-percent mortgages and don't want to sell. Luna: The rate lock-in effect is massive. The Federal Housing Finance Agency estimates that roughly two-thirds of outstanding mortgages have a rate below 4 percent. Those homeowners have no incentive to move unless they have to — job relocation, divorce, downsizing. That's constraining supply and keeping prices elevated. Lucas: And prices are still rising, just more slowly. The Case-Shiller national index is up about 4 percent year-over-year. That's down from the double-digit gains of 2021 and 2022, but it's still running ahead of wage growth, which is about 3.5 percent. So affordability continues to erode. Luna: The National Association of Realtors' affordability index is near its lowest level since the mid-1980s. And that's with mortgage rates that are artificially depressed by builder incentives and lender margin compression. If the ten-year yield keeps climbing, those subsidies will get harder to maintain. Lucas: Let's talk about the bond market reaction. The ten-year breakeven inflation rate is at 2.28 percent, up slightly from 2.26 the day before. That's a market-based measure of expected inflation over the next decade. It's not flashing alarm bells — it's actually pretty close to the Fed's 2-percent target. So the bond market isn't pricing in a resurgence of inflation. It's pricing in a term premium — compensation for holding longer-duration risk in a world where the fiscal deficit is running at 6 percent of GDP. Luna: So the higher ten-year yield is more about supply and fiscal concerns than about inflation expectations. That's a different kind of problem for housing. If the yield rises because of term premium, mortgage rates should follow eventually. But they haven't yet. Lucas: The market is essentially betting that the Fed will cut rates later this year. The fed funds futures are pricing in about two 25-basis-point cuts by December. If that happens, mortgage rates could actually fall, which would relieve some pressure. But if inflation stays sticky and the Fed holds, the yield curve could stay inverted or flatten further. Luna: The two-year yield is at 3.74 percent, so we're still in an inverted curve — two-year above ten-year by about 92 basis points. That's a classic recession signal. But the economy keeps adding jobs — nonfarm payrolls are at nearly 159 million, up from 158.9 million the month before. Initial jobless claims dropped to 208,000, which is very low. So the labour market is still solid. Lucas: That's the puzzle. The unemployment rate ticked down to 4.2 percent from 4.3 percent. Hourly earnings are up to $37.60. Consumers are still spending — the World Cup gave bars and restaurants a boost, according to the Fed's Beige Book. But there are warning signs — credit card debt is rising, and savings rates are declining. Luna: So the housing market is caught in this weird tension. Strong labour market supports demand, but high prices and rates suppress it. Builders are bridging the gap with incentives, but that's not sustainable. Eventually, either rates come down, or prices correct. Lucas: Or something else gives. The Fed's next meeting is in September. If the data between now and then shows core PCE easing, they might have room to cut. But the narrative from Fed Governor Kevin Warsh — who seems to be the new key voice — has been focused on 'patience' and 'data dependence'. He's homed in on three phrases that Fed watchers are parsing: 'restrictive enough', 'time will tell', and 'no rush'. That doesn't sound like someone eager to cut. Luna: So the mispricing in mortgage rates might persist for a while. Lenders will keep compressing spreads, builders will keep offering buy-downs, and the market will sort of limp along. But if the ten-year yield pushes above 5 percent — the long bond is already at 5.15 — the math gets a lot harder. Lucas: And that's the risk. The mortgage market is not pricing in a 5-percent ten-year. If the term premium continues to rise, lenders will have to pass on the cost. That could push mortgage rates to 7.5 percent or higher, which would crater demand and force home prices to fall. The question is whether the Fed would allow that to happen. Luna: They've been clear that they're data-dependent. But if housing cracks, that feeds into the broader economy — construction employment, consumer confidence, bank balance sheets. It's a systemic risk. Lucas: For now, the market is betting on a soft landing. But the housing market is the most fragile part of the landing gear. We'll be watching the next CPI and PCE prints — especially the shelter components — and the Fed's September statement. Luna: And the next jobs report and JOLTS data. Job openings ticked up to 7.594 million in May. If openings stay high and layoffs stay low, the Fed has more room to hold. Lucas: Right. So the disconnect between the bond market and the mortgage market is a story about incentives, expectations, and a bit of wishful thinking. It's one of those things that works until it doesn't, and when it breaks, it could break fast. Luna: And we'll be here to track it. That's it for today's Macro Memo. Thanks for listening. Lucas: Catch you next time.