Information provided by the Federal Housing Financing Agency indicates that mortgage rates on purchases of newly built homes ticked up by 3 basis points over June to 4.03 percent. However, at this level, rates remain below the 4.18 peak level recorded in February. Meanwhile, a more commonly used rate reported by Freddie Mac indicates that mortgage rates fell in June. Despite some monthly divergence, the two series track each other.
A previous post highlighted the role that inflation played in determining mortgage rates since rates began a multi-month increase in October 2016. Stronger inflation contributed to the increase in mortgage rates between October 2016 and February 2017 and weaker inflation accounted for the decline in rates in the 3 months since February 2017. This analysis was predicated on the fact that changes in the rate on the 10-year Treasury note had a larger impact on mortgage rates than changes in the mortgage risk premium.
In addition to assessing the inflation and the “real” component of the 10-Year Treasury note rate, analysts can also compare the 10-Year Treasury note rate with the rate on the 3-month Treasury bill. The economic interpretation is that the rate on the 3-month Treasury bill reflects the market’s view of the economy in short-run, while the spread between the two rates represents the market’s view of economy’s performance in the longer-run relative to the economy’s performance in the shorter-run.
As the chart above illustrates, between October 2016 and February 2017, the rate on the 3-month Treasury bill increased by 20 basis points, consistent with the 25 basis point increase in the target federal funds rate made by the FOMC in December 2016. Meanwhile, the spread between the rate on the 10-Year Treasury note and the rate on the 3-month Treasury bill rose by 46 basis points. An economic interpretation is that financial market’s view of the economy in the short-run improved, consistent with communication and decision-making by the FOMC, and, relative to the short-run, the market’s view of economic performance in the longer-run also strengthened. The risk premium associated with mortgage lending was basically unchanged, falling by 2 basis points over the period.
Since February, the market’s view of the economy’s performance in the shorter-run has continued to improve in line with the FOMC’s actions. The rate on the 3-month Treasury bill rose an additional 47 basis points reflecting the two 25 basis point increases in the targeted federal funds rate in 2017, one each in March and June.
The increase in the federal funds rate since February 2017 would suggest that mortgage rates should rise as well, a dynamic that took place over the October 2016 to February 2017 period. The rate on the 3-month Treasury bill has increased in response to monetary policy. However, the 10-Year Treasury note rate fell by more than the increase in the 3-month Treasury bill rate, reflecting a slowdown in the expectations for inflation, a concern highlighted by the FOMC in its most recent statement. At the same time, since the rate on the 10-Year Treasury note fell while the rate on the 3-month Treasury bill rose, then spread between the two rates shrank. The decline in the spread suggests that the market’s view of the economy in the longer-run had eroded somewhat relative to its view of the economy in the shorter-run, which had improved.