When mortgage rates blew past the 7% level earlier this year, the securitization market “froze up temporarily,” according to Doug Duncan, senior vice president and chief economist at the government-sponsored enterprise Fannie Mae.
“Investors who would buy a mortgage-backed security [MBS], which is backed by mortgages that have a 7% coupon, believe that when the Fed eases interest rates, the people with those 7% mortgages will refi,” Duncan said on Friday during the AIME Fuse 2023, the Association of Independent Mortgage Experts’ conference held in Las Vegas.
Duncan added: “So what you also almost immediately saw was buydowns of interest rates. The market responded within two weeks. The market set the problem and responded with a solution to keep consumers in the game.”
Until it happened again. Duncan said that now the rates have shot up to the 7.5% to 8% range, the same thing is true.
“The question is: Is there a way to encourage investors to continue to buy mortgage-backed securities, which is a major funding mechanism for home purchases and refinancings, with the knowledge that it’s likely that when the Fed gets inflation back, interest rates going to fall, those mortgages will refinance and those mortgage-backed securities will disappear?” Duncan added.
One caveat: “If you’re saying even more extended buydowns, [even] for those [lenders] who have had strong profit margins, the profits at some point are going to be exhausted.”
With fewer buyers in the MBS market, the average coupon yield on 30-year agency MBS was at around 6.4% at the end of September, The Wall Street Journal reported. That was a 1.8 percentage point premium to the 10-year Treasury yield versus a 21st-century average of around one point.
When you add mortgage originators’ profits, the 30-year fixed rate averaged 7.49% as of Oct. 5th, up 28 basis points from 7.31% in the previous week. At HousingWire’s Mortgage Rates Center, rates were 7.6% on Friday.
According to Duncan, the Federal Reserve (Fed) is still the single biggest holder of MBSs worldwide, with about 21%. Banks and credit unions together own about 29% as a group.
“But the Fed no longer wants to hold them, so they are not buying; they are actually letting them run off,” Duncan said.
The central bank currently holds about $2.6 trillion in MBSs as part of its roughly $8 trillion securities portfolio. To reduce its balance sheet as part of the plan to tighten monetary policy, the Fed is allowing up to $60 billion a month in Treasury securities and $35 billion in MBSs to mature and roll off from its holdings.
Meanwhile, Duncan said, “We don’t expect spreads to come down anytime soon.”
Duncan forecasts that mortgage rates are likely to range between 4.5% and 6% in the long term. His base scenario is for the Fed to start reducing rates at the end of 2024, as a “mild recession” is expected for the first quarter of next year.
“What do I mean by a mild recession? I mean three quarters over which economic growth will decline by about 0.5% or 1%. Pretty much the reason is housing — because housing is so tight,” Duncan said.
“[Housing] typically is one of the leading things that take the economy into recession, but it’s in a sense already there, given the level of activity in the housing market, so it’s not going to be the size of drag that would typically be the case in a recession.”
