Market Review - November 13th, 2023

Market Review - November 13th, 2023

A confluence of events helped mortgage rates to decline meaningfully last week, but even the largest one-week decline in about 15 months was only enough to return them to about month-ago levels. While any decline in rates these days is welcome, it will take several significant declines to return them to something potential borrowers will find more palatable.

Interest rates began settling back after the November 1 Fed meeting, as investors seemed cheered by a Federal Reserve that seems in no hurry to raise short-term rates again (or may even be done for this cycle). The Fed still officially retains a "hawkish" stance, where prospects for another hike in short-term rates at the December meeting remain, but futures markets bets place less than a 10% probability of this occurring, down from more than double that figure a month ago. If the Fed is satisfied (or nearly satisfied) with the present stance of monetary policy, this suggests to investors that cooler economic times and lower inflation pressures may be starting to form.

Amid a sea of new debt being issued by the Treasury, a tweak in the distribution of new bonds being issued also helped longer-term rates to ease a little. The Treasury announced that there would be a smaller increase in the number of longer-term bonds being issued in the coming quarter and a shift toward shorter-term instruments. Recently, there has been a greater appetite by investors for shorter-term bills and notes, and large supplies and slack demand for longer-dated bonds recently pushed yields up to about 16-year highs. Less new long-term debt supply coming online helped yields on these instruments to drop, in turn helping mortgage rates to decline.

A third factor likely contributed to the easing in rates, too. The increase in interest rates this year -- and especially since summer began -- means fewer mortgages were made. In turn, this means fewer mortgage-backed securities for investors to buy, not that investors have been in any kind of rush to snap up MBS this year as the Fed and many banks have been reducing their holdings. Industry news source Inside Mortgage Finance noted that Fannie and Freddie MBS issuance dropped by 10.1% in October compared to September and is currently at the lowest level since March. Since there has been little improvement in originations (if any) of late, it seems likely that MBS issuance still has space to shrink. Fewer MBS to available helps support their prices, allowing yields to decline a little.

What would really help them to decline would be a reduction in spreads, but it may be some time before we see them shrink from present extraordinarily wide levels. Even getting them back to something approaching normal -- about 160-180 basis points above the yield on the 10-year Treasury -- would see 30-year fixed mortgage rates more than a full percentage point lower than today even if underlying rates remain pat. To get there would need to see a considerable change in investor demand for MBS, less government debt issuance (which competes for many of the same investor dollars) and more.

The decline in interest rates and mortgage rates seen last week wasn't all that great, but at least provides a reason for optimism that at some point we will begin to see more routine declines in rates, even if not as large as was this week's shift. To get to that sort of pattern of decline, the Fed will need to be more fully convinced that inflation is at least headed back into its bottle; in turn, investors need to more firmly believe that the Fed is not only done raising rates but that the prospects for lower rates are starting to be more realistic. At the same time, we'll likely need to see some improvement in the appetite for mortgage-related debt investments to help spreads move at least a little closer to normal. The Fed getting its balance sheet whittled down to a size it desires will help here, too, but given budget deficits and outstanding debt that needs to be managed, less competition from government bond sales isn't likely to be seen any time in the near future.

We'll get October updates on Producer and Consumer Price Indices next week. If they are favorable, the firming in yields from poor Treasury auctions and Mr. Powell's comments may be erased. Conversely, if progress on inflation is stalling or stalled, Mr. Powell's comments about the Fed being ready to do more to combat inflation may press them upward a bit. Next week, we'll get an update on builder and home construction activity in October. With this as a backdrop, and based on how Treasury yields ended last week, it looks as though we'll see a modest increase in mortgage rates this week, likely something on the order of six or seven basis points in the average offered rate for a conforming 30-year FRM as reported by Freddie Mac come Thursday.

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