Information provided by the Federal Housing Financing Agency (FHFA) indicates that mortgage rates on purchases of newly built homes rose 7 basis points in November to 4.00 percent. At this level, rates remain below the 4.18 cycle peak level recorded in February. Meanwhile, a more commonly used rate reported by Freddie Mac indicates that mortgage rates rose by 2 basis points in November to 3.92 percent and by another 3 basis points in December to 3.95 percent. Despite some monthly divergence, the two series track each other.
Since the rate information provided by Freddie Mac tracks the FHFA series on new construction specifically, then assessing the more often cited mortgage rate data from Freddie Mac’s Primary Mortgage Market Survey gives a look at the performance of mortgage rates over 2017. The figure below indicates that rates rose 34 basis points in 2017 to 3.99 percent. Despite the increase, mortgage rates ended 2017 under 4.0 percent for the fifth time in six years and remain at a historically low level. The figure below illustrates that the 49 basis point increase in the 10-Year Treasury Note rate between 2016 and 2017 was partially offset by a 15 basis point decline in the mortgage risk premium, which is the residual between the 30-Year Fixed Rate mortgage rate and the 10-Year Treasury Note rate.
Mortgage rates have been broadly declining since 2006. Over this period, mortgage rates have fallen 242 basis points from 6.41 percent to 3.99 percent and the 10-Year Treasury note rate was largely responsible for the fall in mortgage rates. The broad decline in mortgage rates since 2006 reflects a 246 basis point decrease in the 10-Year Treasury note rate. Meanwhile the mortgage risk premium rose 4 basis points, with volatility, over the same period. A previous post illustrated that monetary policy in the wake of the recession was targeted at the increase in the mortgage risk premium between 2006 and 2008 and these policies were partly responsible for the decline in the premium that ensued.
Decomposing the 10-Year Treasury Note rate into its component parts, the real return and inflation compensation, suggests that both components contributed to the increase in the 10-Year Treasury Note rate in 2017. Inflation compensation rose by 30 basis points to 1.87 percent while the real return, taken from the rate on the 10-Year Treasury Inflation Protected Securities (10-Year TIPS), increased by 19 basis points to 0.46 percent. However, the low rate on the 10-Year Treasury Note, when comparing its rate in 2017 with its local peak rate in 2006, the year that mortgage rates peaked locally, reflects a depressed real return. The real return on the 10-Year Treasury Note in 2017 is 185 basis points below its level in 2006 while the inflation compensation component in 2017 was 61 basis points below its 2006 level.
In 2012, the real return fell to negative 0.48 basis points. This means that investors were paying, in real terms, for the opportunity to lend to the federal government. A previous post demonstrated how the shift from a negative real rate to a positive one occurred in response to the “taper tantrum”, comments by then-Chairman Bernanke that the Fed would unwind its bond-purchases. At the same time, earlier analysis illustrated how the October 2017 increase in mortgage rates reflected a rise in the real return on the 10-Year Treasury Note rate. This was the month that the Fed began to normalize its balance sheet. Combined, these two events beg the question whether Fed bond purchases, either actual or expected, are related to the decline in the real return over the last downturn.
The figure above plots the real return on the 10-Year Treasury Note (the left axis) with the natural log of Fed holdings of longer-dated US Treasury securities, those maturing in 5 years or more. The natural log is used as a proxy for the growth in Fed holdings, most likely resulting from purchases. The right-hand (secondary) axis, which plots the Fed purchase volume, is inverted so that the increase in bond-buying corresponds to a decline in the curve.
The figure suggests that trends in the real return on the 10-Year Treasury Note rate track the growth in Fed purchases of longer dated Treasury Securities between 2003 and 2012, with a tighter correlation between 2008 and 2011. In 2013, comments by Chairman Bernanke reversed the trend of the real return as the market priced in its expectations of normalization even though Fed purchases continued. Since 2014, the real return has remained above the trend in Fed holdings of longer-dated Treasury securities, but the gap between the two has shrunk. It is possible that a third dynamic such as a recession or stronger economic growth, is responsible for both the increase in Fed purchases and the decline in the real return.