Daily average mortgage rates have reached their highest level since October, standing at 7.26%. As a result, mortgage-purchase applications have dropped to their lowest level since October. This can be attributed to two economic factors that are counteracting the positive impact of promising inflation data and expectations of the Fed cutting interest rates next year.
The first factor is the increasing concern among investors that the U.S. government has accumulated too much debt. There is worry that the U.S. Treasury might issue an excessive amount of new treasuries to finance this debt, which would decrease the value of treasury debt and raise bond yields or interest rates.
The second factor is related to long-term expectations regarding the level of interest rates necessary for the Fed to maintain a balanced economy. This is referred to as the real neutral rate of interest, or r-star. Following the financial crisis, it was widely believed that r-star had decreased, which explained the prolonged period of low interest rates and low inflation. However, research conducted after the pandemic has indicated that r-star may be rising. When combined with expectations of the Fed successfully achieving a soft landing, this leads to higher 10-year treasury yields and interest rates.
Nevertheless, there is a possibility that mortgage rates could decrease even if the 10-year treasury yield remains high. In the past year, the difference between the 10-year treasury yield and mortgage rates has been larger than usual. This suggests that mortgage rates could potentially decrease without a corresponding decrease in the 10-year treasury yield if certain buyers of mortgage debt, such as banks, re-enter the market.
