This past Independence Day could prove to mark the beginning of "dependents day" as well. The 10-year Treasury yield finally breaking below its previous record low may prove to be the precursor to mortgage rates declining to record lows, too. That, in turn, finally should provide the push necessary to increase the number of first-time buyers moving into the housing market.
This process will not be immediate, however. It probably will build over the rest of this year and set up next spring for the first truly strong housing market since the height of the residential subprime mortgage market in 2005-2006, over a decade ago.
I've been contacted by many mortgage and real estate folks over the past several days expressing frustration with the slow decline in mortgage rates. They've asked whether rates will decline further or have hit a structural low in the 3.5% range for a 30-year, fixed-rate conventional mortgage.
I understand the frustration. Mortgage spreads, both commercial and residential, including multi-families, have widened at almost the same pace that the 10-year Treasury yield has declined over the past several weeks. The result is that while mortgage rates have declined, the reduction has not been by much or nearly what mortgage companies or home buyers have been expecting.
The relationship between the 10-year Treasury yield and mortgage rates is not fixed. When Treasury yields are declining, mortgage rates will lag that decline because mortgage-backed securities (MBS) buyers are hesitant and cautious about assuming that the decline in Treasury yields will be long-lived.
That situation forces mortgage originators such as Wells Fargo (WFC), Bank of America (BAC) and JPMorgan Chase (JPM) to keep the mortgage rates at levels that are conducive to a liquid MBS market.
In order to do so, the mortgage spreads actually widen as Treasury yields decline.
Right now there is still much concern by MBS buyers that the decline in Treasury yields is a temporary phenomenon driven by the Brexit referendum results, and that yields will reverse and head higher again as the economic and global financial market impact of it are better understood.
That may be true in the near future, but as clarity on that issue is forming, investors are also beginning to exhibit concerns about the immediate prospects for the global economy. And those concerns are more fundamental and broader than just whether the British secede from the European Union.
As those concerns mount, it is probable that Treasury yields will decline further, thus causing fears of an imminent reversal in those rates to dissipate among MBS buyers. That, in turn, will cause MBS buyers to become willing to accept lower-yielding mortgages and will allow mortgage spreads to reverse their recent widening and start to follow the Treasury yields.
I do not expect this to be an immediate resetting of mortgage rates and spreads. However, if global economic trends continue over the next several months -- and I expect that they will -- key round numbers will be broken. The three most important of them are the yield on the 10-year Treasury, 30-year Treasury and 30-year fixed-rate mortgage.
I expect that 30-year Treasury will break below 2%. That will be followed by the 10-year Treasury breaking below 1%, and finally the 30-year fixed rate mortgage breaking below 3% at par.
As these events occur, the financial media will fixate on them and in the process ensure that everyone is aware of the implications for housing prices, transactions, carry costs and so forth. That attention will provide the first substantive rationale for first-time home buyers with the capacity to purchase to do so since the rapid expansion of the subprime mortgage market in the early 2000s.
There are still many other associated issues that will help determine how quickly this occurs and to what levels mortgage rates fall. The biggest of these is when the Fed decides to reverse course on monetary tightening and how it does so.
If the Fed decides to launch another round of quantitative easing targeted at the purchase of mortgages, the process of the round numbers being hit that I wrote about earlier could be reached more quickly than next spring. The combination of record-low mortgage rates attracting first-time home buyers with a Fed commitment to supporting the stabilization of rates by way of purchasing mortgages again should lead to increased liquidity in the MBS space and a steady reduction in mortgage spreads.
I don't know if the Fed will do that or when it will reverse course, but the process I've outlined should occur even if the Fed does not change course soon or if it doesn't increase mortgage purchases again.
Beyond the largest mortgage originators referenced earlier, the prime beneficiaries of lower mortgage rates should be the stock prices of the home builders with the greatest focus on first-time buyers; among them are Beazer Homes USA (BZH) and Hovnanian Enterprises (HOV).