In the United States, pent-up demand for single-family homes is as high as 6.5 million units. But supply is very limited because many homeowners are locked into existing mortgages with rates as low as 3%. Because of inflation, caused by excess stimulus and global supply chain disruptions, prices for single-family homes have soared.
Now housing inflation has stabilized, and the outlook for interest rates is turning positive.
With inflation falling faster than expected and the Federal Reserve nearing its 2% price inflation target, the process of normalizing interest rates is about to unfold. As the Fed cuts rates, the cost of conforming 30-year mortgages will also fall. Today, the cost of a conforming 30-year fixed-rate mortgage is about 6.8%. A conforming mortgage is a mortgage Fannie Mae or Freddie Mac can purchase. Those two companies improve liquidity in the mortgage market. Most mortgages in the U.S. are conforming.
The rate on a 30-year fixed rate mortgage is priced off the yield on the 10-year Treasury. That Treasury yield is currently around 4.08%. Usually, the difference between the yield on the 10-year Treasury and the cost of a 30-year conforming mortgage is around 2%. But in times of stress, which the economy experienced as the Fed aggressively raised rates, the relationship between the mortgage rate and the 10-year Treasury breaks down. Lenders demand higher returns to reflect higher risk. Today, risk and returns are normalizing. The spread will close from the current 2.6% toward the more typical 2%.
During 2024, the yield on the 10-year Treasury should fall significantly because inflation is falling faster than anticipated. On a six-month basis, the Fed has reached its 2% inflation target. In fact, core inflation is running at 1.9%. The Fed says that interest rates will fall by 0.75%, 75 basis points this year. Traders think rates will fall even more.
Regardless, the cost of mortgages will fall. That will spark demand for single-family homes.
The outlook for the residential housing market is also dependent on the state of the economy. There, too, the news looks good. The Federal Reserve Bank of Atlanta sees first quarter GDP growth at almost 3%, and the investment firm Goldman Sachs sees 2024 GDP growth at 2.1%. A reasonably strong economy, combined with full employment, rising consumer confidence, and falling interest rates, spells good news for the residential housing market.
Still, the relative strength of the housing sector in 2024 will largely be dependent on mortgage rates. Respected forecasters believe that in 2025, as inflation continues to fall and as the Fed cuts rates, the yield on the 10-year Treasury could fall to as low as 3%. Assuming that the spread between the 10-year Treasury and the interest rate on a conforming 30-year mortgage remains in a range of 2%-2.5%, it is easy to see that the average rate on a conventional fixed-rate mortgage could fall to 5.5% or lower by December 2024. A fall of over 1% in the cost of a mortgage could create the conditions for a very strong residential housing market.
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The market is short over 6 million units. As mortgage rates fall and as more homes are purchased and sold, demand for both home appliances and remodeling services will also ride the residential housing wave. Investment in residential housing and related sectors should generate positive returns.
Owning a home is a good way to build wealth and ensure financial security.
