Current Mortgage Market: Inflation, Treasuries, and the Banking Crisis


It’s time to address an intriguing trend in the mortgage market – the unusual downward movement of mortgage rates. This shift seems contradictory, as one would expect the rates to climb instead. To unpack the dynamics at play, let’s delve into the fundamentals of supply and demand, inflation, and the ongoing banking crisis.

Unfolding the Enigma of Mortgage Rates

On May 10th, we saw the inflation number we’d longed for, but the market reaction was different than we predicted. Mortgage bonds were not following the decrease in inflation as they usually would. So, what happened?

Banks in the US have been offloading large percentages of their holdings of treasuries and agencies since March. One potential explanation is the recent banking crisis. Banks are experiencing a drop in deposits as they compete with money markets offering nearly 5%, leading them to raise capital to make up for this deficit.

As bank stocks have dropped precipitously, raising capital from stock sales has become difficult. Banks are thus offloading Treasuries and mortgage-backed securities, even though it results in a realized loss. It’s their only option. This unprecedented selling has caused mortgage rates to remain stubbornly high, despite the decrease in inflation.

The Debt Ceiling Uncertainty

Adding fuel to the fire, the ongoing debt ceiling uncertainty needs to be improved. As we know, inflation is decreasing, and long-term rates should follow suit. But we are still weathering the storm of great selling. When the situation stabilizes, we expect the fundamentals to take over.

Looking at the Federal Reserve

Interestingly, the Federal Reserve has also chimed in. Federal Reserve Chair Jerome Powell mentioned that the Fed funds rate may not need to rise as much as anticipated due to the bank credit stress we’re seeing. The Fed’s acknowledgment of the current situation potentially indicates a pause in their next meeting.

However, the Fed’s reliance on old data – their ‘rearview mirror’ approach – may prove problematic. For instance, in 2021, the Fed overlooked real-time indicators showing inflation going up, instead sticking to lagging CPI data, thereby exacerbating the inflation problem. The same mistake may happen again but in reverse.

The Housing Market Heats Up

Amid these economic intricacies, the housing market is thriving. According to the Realtor Confidence Index survey for April, 73% of homes sold in less than a month, and 33% of properties sold above the list price – up from 28% the previous month; the average days on the market also dropped to 22 from 29 last month.

This surge in the housing market is vital, especially as we expect inflation to continue moderating and mortgage rates to decrease eventually. Clients sitting on the sidelines might want to take advantage of today’s opportunity in housing.

Upcoming Economic Indicators

In the coming days, new data will come to help shape our understanding of the current economic landscape. Tomorrow, we will get new home sales figures. On Thursday, the second read on Q2 GDP will come out, along with pending home sales. On Friday, we will see the Fed’s preferred measure of inflation, PCE.

As it stands, mortgage-backed securities are on a floor of support, tested successfully last Thursday and Friday, and again today. We hope the downturn will be reversed and mortgage bonds will see a positive trend. We also hope the selling we’ve discussed will subside.

The current mortgage market situation may seem frustrating, but it’s crucial to remember that these events, though sudden and unexpected.