Morgan Stanley analysts argue that mortgage rates follow the 5- and 10-year Treasury yields, not the Fed Funds rate. As evidence, they note that while the Fed has cut rates by 100 basis points over the past year, the average mortgage rate has actually increased by 25 basis points during the same period.
A significant housing market recovery requires a substantial and sustained improvement in affordability. Analysts estimate a 100-basis-point drop in mortgage rates (e.g., to 5.5%) is needed to trigger a meaningful pickup in sales. However, this growth is not immediate; sustainable increases in sales volumes typically materialize a full year after the affordability improvement occurs.
The gap between existing mortgage rates (under 4.25%) and new rates (over 6.25%) is over 200 basis points. This spread, which disincentivizes homeowners from selling, has persisted for three consecutive years. Historically, the gap only exceeded 100 basis points for a total of eight quarters over the past four decades, making the current situation a major anomaly.
The bond market is a better indicator for mortgage rates than the Fed. The current spread between 5-year and 10-year Treasury notes implies that investors expect the 5-year note's yield to be 100 basis points higher in five years than it is today. Since mortgage rates are closely tied to these yields, this suggests a potential for higher, not lower, mortgage rates in the medium term.