Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Tucked away in my desk is a "mortgage calculator" I got from a bank-loan representative back in 1996, when my husband and I were looking to buy our first home. It's a simple sliding scale that shows how much someone's monthly payment is per $1,000 of mortgage debt, depending on the length of the mortgage and the interest rate. But what's fascinating is that the interest-rate options on the calculator range from 20% to 6%. That's right, back in 1996, banks seemed unable to even contemplate rates below 6%.
I've kept this mortgage calculator all these years because it's a time capsule from a different era, reflecting the monetary policy of the 1980s and 1990s. Today, mortgage rates reflect a far more expansive monetary policy. However, we've seen an uptick in mortgage rates in recent weeks, prompting some market observers to worry about its impact on the housing recovery. In fact, last week, mortgage rates rose for the sixth consecutive week. The average rate for a 30-year fixed rate mortgage increased to 3.98%, a 14-month high according to Freddie Mac.
It's important to note that US mortgage rates are not rising because the Federal Reserve has altered its monetary policy. They're rising because investors fear that the Fed will begin tapering its asset purchases, or QE3, and have begun selling off Treasuries and mortgage-backed securities in anticipation of this move. Some market pundits are already starting to raise concerns, fearing that the housing recovery may stall as a result of higher mortgage rates. News that the total number of US mortgage applications filed in the last week of May decreased 20% from the prior week could be a sign of how damaging higher rates can be. However, it may be too hasty to make the assumption that the housing recovery has been derailed. Consider that even if mortgage rates go up 50 basis points from here, they will remain very close to all-time historical lows. After all, we are at an all-time high for housing affordability, three standard deviations away from the average for housing affordability
Also, it's important to consider that investors may be wrong in predicting that tapering will occur in the near term. Our view is that tapering is more likely a 2014 event, as we may not see any real improvement in the labor market in the back half of this year. Also, if and when the Fed begins to taper, it's not clear exactly how it will be done. For example, of the $85 billion in bond purchases each month, perhaps the Fed will reduce its portion of government bond purchases but not its purchases of mortgage-backed securities.
In fact, that's exactly what Boston Fed President Eric Rosengren has advocated: tapering the purchase of government bonds but not mortgage-backed securities. Also, tapering does not necessarily mean an official rate increase, which would have a much bigger impact. Money market curves are not currently pricing in higher interest rates, which means the reaction in yield (both mortgage and US Treasury rates) is a reflection of a reduction in the Fed's asset purchases.
And we're overlooking the bigger issue, which is that many homeowners haven't been able to take advantage of low interest rates because banks have very tight lending standards. Indeed, less-than-stellar credit and underwater mortgages have been obstacles standing between homeowners and lower mortgage rates. If the Fed can come up with solutions to resolve these issues, then it may provide a much bigger boost to the housing recovery than any drag created by higher mortgage rates. For example, the Fed recently published a creative proposal on how state and local governments could use eminent domain to lower the principal loan balance on underwater mortgages. The Fed clearly remains focused on helping more homeowners avail themselves of current mortgage rates—an encouraging sign for further housing strides.
Chances are we'll see more jitters in the coming week as investors fret about the FOMC meeting. Mortgage rates could rise even further. However, it's important that investors don't conclude too hastily that the housing recovery is over.
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