Too Strong For Lower Rates
New: HSH's 2025 Mortgage and Housing Market Outlook
January 10, 2025 -- It's shaping up to be a rough winter season for potential homebuyers, and not just because winter weather and storms have arrived. While these things certainly are a deterrent to shopping for houses, mortgage rates back up to early-summer highs and threatening to go higher still are certain to challenge potential homebuyers even further.
Back at the end of October, after the first cut in rates by the Fed (but before the second), we wondered "Was the economy too strong to warrant a half-point cut by the Fed?" After another rate cut came in November, we pondered this topic again, and in the December 13 MarketTrends we proffered "The question perhaps is whether the expected rate cut next week is warranted or needed," given the strength of the data and lack of progress on inflation.
Of course, the Fed did cut again in December, so short-term rates were lowered by a good bit fairly quickly. Long-term rates, however, are driven by investor demands and concerns, and market-based yields have risen nearly steadily since the Fed made its first move back in late September. Given this, it might be a reasonable conclusion to think that "yes, the economy was too strong, and the additional cuts to close 2024 probably could have been spread out or even delayed for a time."
Certainly, core PCE inflation hasn't much retreated since the mid-point of last year, at least on an annualized basis, and the economy and labor markets have proven to be highly resilient to the effects of still fairly-high interest rates. And, as it turns out, at least some Fed members didn't hold a strong conviction that rates should have been cut last month. While a "vast majority" of the 12 FOMC voting members supported a quarter-point cut, "A majority of participants noted that their judgments about this meeting's appropriate policy action had been finely balanced." In fact, "Some participants stated that there was merit in keeping the target range for the federal funds rate unchanged," and there was on voting member who expressly preferred doing just that. A "majority" had doubts that a cut was the right thing to do, one didn't want to cut rates at all, but a "vast majority" did so anyway.
It may be that the Fed continued to trim rates into the late fall in order to help provide some relief to small businesses. Large companies may have access to the capital markets, where financing costs (at least in terms of yield spreads) have been pretty favorable, while others' balance sheets may have been buoyed by high stock values. Conversely, smaller firms often use bank loans to finance operations, and lowering short-term rates can help ease costs, something that is likely helpful now that pandemic-era supports have disappeared from the rear-view mirror. Lower rates may also help support the beleaguered manufacturing sector, as everything from routine inventory resupply to high-ticket one-off items often need financing for orders to be placed. Possibly reflective of this, the ISM Manufacturing index firmed up in both November and December, as new orders broke over the breakeven level in each of those months, with December's new order figure the highest since May 2022.
Still, whether the overall economy needs the kind of boost that lower rates may bring is quite debatable. The service side of the economy -- many times larger than manufacturing -- was mostly doing fine before the Fed began cutting rates and somewhat more so after. For December, the Institute for Supply Management's service-business barometer kicked higher by two points to a value of 54.1, moving from a modest level of activity to a moderate one. New orders solidified a bit further, rising by 0.5 point to 54.2, while employment held nearly steady with a 0.1 slip to 51.4 for the month. However, the "prices paid" component flared sharply higher, climbing 6.2 points to a too-warm 64.4 last month, and this may (and probably should) raise an eyebrow or two at the Fed, as it is the highest such reading in almost two years.
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Those waiting or expecting to see material deterioration in labor conditions will continue to have to wait. The update to the Job Openings and Labor Turnover Survey (JOLTS) for November showed an uptick in the number of available positions, which climbed from an upwardly-revised 7.839 million to 8.098 million, the most openings since May. Despite more open slots, the hiring rate continued on an easing pattern as companies appear to be a little more selective or deliberate in their choice of candidates they add. However, once folks have a job, they are sticking with it; layoffs of existing employees was little changed at a low level in November, and voluntary separations (aka "quits") also retreated.
The Employment Situation report for December also pointed to very solid conditions. Last month, there were 256,000 new hires, up from a downwardly-revised 212,000 in November, and the moving three-month trend for hiring was the strongest since last spring. The official unemployment rate slipped back down a notch to 4.1%, and has been more or less steady for the last seven months. Another 243,000 persons entered the workforce last month, a solid rebound after a couple of months of declining participation, and the overall percentage of folks engaging the labor market remained at 62.5%, exactly where it has been in each of the last three months. In perhaps a positive for the inflation outlook, wage growth came in at 0.3% for the month, enough to help the annual rate step down to 3.9%, a little closer to a rate that may better help promote 2% inflation over time.
In its odd way, the nation's trade deficit also reflects a strong economy, as well as the effects of a strong dollar. The aggregate gap in the value of goods and services coming into and leaving the U.S. expanded by $4,6 billion in November to $78,2 billion for the month. Despite the cost-lowering effects of a strong greenback, imported goods expanded by $11.7 billion, as the strength of demand here pulled in more from our trading partners;. Exports managed a $7.1 billion increase despite U.S. made goods and services being more costly due to the strong dollar. It remains to be seen how these figures are affected by the expected imposition of new tariffs the incoming administration has promised.
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Looking a little backward, overall factory orders slid by 0.4% in November, Despite the headline number's decline, orders for non-durable goods were positive, rising by 0.4%; it was durable goods orders that dragged the top-line figure down, posting a 1.2% decline for the month as transportation-related orders were down. However, the core measure of orders -- exclusive of pricey aircraft and other distortions -- sported an increase of 0.4%, so this proxy for business-related investment had it's best showing since last June.
A solid month for sales at the nation's wholesaling firms may prompt some more orders for manufacturers as we move into 2025, too. For November, sales rose by 0.6%, a nice rebound from a 0.3% decline in October. The bump in orders depleted inventories of durable goods, which shrank by 0.4%, but non-durable goods holdings thickened by 0.2% as a counterbalance. The overall decline in stockpiles left the inventory-to-sales ratio at 1.33 months supply of goods on hand, the leanest inventory levels have been at wholesalers since September 2023, so new orders to manufacturers are somewhat more likely to come.
Consumers bought more new vehicles to close 2024. The Bureau of Economic Analysis reported that new cars and light trucks rolled off dealer lots at an annualized 16.80 million pace, up 0.6% compared to November and 5.5% higher than December 2023. The sales pace was just high enough to be the strongest since May 2021. With an aging fleet of vehicles on the roads, financing costs likely somewhat lower and more dealer promotions to be seen, there is probably still some upside for auto sales this year.
Trends in consumer credit balances continue to be a little perplexing. In November, overall consumer debt levels held by banks actually shrank by $7.5 billion, the third time in the last six months such a phenomenon occurred. In each of these instances, it is balances on revolving accounts -- mostly credit cards -- that has shrunk. In November's case, there was a $13.7 billion decline, nearly fully paying off October's $15,2 billion borrowing binge. Retail sales rose at a solid clip in November, so it doesn't appear that consumers are retrenching, but perhaps households that are more likely to use credit cards to finance day-to-day needs are becoming more cautious. In all, it's not clear what's causing these swings, but it may be that a combination of buy-now, pay-later financing methods and perhaps greater use of cash to avoid credit-card surcharges being passed along by many outlets are contributing. Regardless, installment-type debt (auto, education and personal loans) did see a $6.2 billion increase, and probably helping to power the auto sales noted above.
Based upon the trend for initial unemployment claims, we already surmised that there were fewer layoffs in December. The December update from the outplacement firm of Challenger, Gray and Christmas reflects this clearly, as announcements affecting just 38,792 positions were tallied, down from 57,727 in November and the fewest since July. It seems as though this may carry into the new year as initial claims for unemployment benefits in the week ending January 4 came in at only 201,000. To be fair, it was a holiday week, and so there may be some seasonal adjustment distortion in the figure, but on a "raw" basis this was the fewest applicants for assistance since February 17 of last year. Ongoing assistance claims did rise a bit but remain below recent three-year highs.
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Holiday weeks and high mortgage rates aren't the recipe for increased mortgage activity. The Mortgage Bankers Association reported a 3.7% decline in requests for mortgage credit in the week ending January 3, pulled down by a 6.6% drop in applications for loans to buy homes. More paperwork to refinance existing loans was filed, however, as there was a surprising 1.5% increase in applications to replace existing loans with new ones. Of course, this mild increase wasn't much of an offset to the prior week's 23.4% decline, and describing current mortgage activity as sluggish might be overly optimistic. We'll see if the move out of the holiday season improves things any, but rates moving higher suggests otherwise.
Consumer moods started 2025 at roughly the same overall place as they finished 2024, according to the University of Michigan. Their survey of Consumer Sentiment edged 0.8 point lower to 73.2 in the preliminary January poll. Present conditions were assessed more favorably, rising 2.8 points to 77.9 so far this month, while expectations turned less so, sliding 3.1 points to 70.2, a six-month low should it hold for the entire month. In addition to the increase in services prices paid detailed above, the Fed may note the significant change in inflation expectations in this poll. The one-year outlook for prices rose from 2.8% just a few weeks ago to 3.3%, a seven-month high, and the five year outlook rose to 3.3% from 3%, the highest in the series to date (January 2015). If price pressures appear to be rising and inflation expectations are becoming less "well anchored", any rate cuts at all this year might soon be off the table.
Current Adjustable Rate Mortgage (ARM) Indexes
| Index | For The Week Ending | Year Ago | |
|---|---|---|---|
| Jan 03 | Dec 06 | Jan 05 | |
| 6-Mo. TCM | 4.25% | 4.39% | 5.25% |
| 1-Yr. TCM | 4.17% | 4.24% | 4.83% |
| 3-Yr. TCM | 4.29% | 4.10% | 4.12% |
| 10-Yr. TCM | 4.58% | 4.19% | 3.98% |
| Federal Cost of Funds |
3.767% | 3.834% | 3.848% |
| 30-day SOFR (daily value) | 4.51125% | 4.62428% | 5.33743% |
| Moving Treasury Average (MTA/12-MAT) |
4.686% | 4.747% | 5.081% |
| Freddie Mac 30-yr FRM |
6.91% | 6.60% | 6.66% |
| Historical ARM Index Data | |||
There's certainly the prospect for more volatility for rates coming next week, too, as December updates to Consumer, Producer and Import and Export prices are due. The economy is cruising along at a solid pace and labor market conditions are still very solid, and in order to have any hope for falling longer term rates anytime soon, at least some fresh progress on inflation needs to be seen, and soon.
Even if improved, next week's reports on inflation (and a pile of other observations) won't come in time to stop the effects of the increase in underlying yields that most influence mortgage rates that took place in recent days. Based upon how these yields moved this week, we expect to see a 9-12 basis point increase in the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac. Simply stated, the economy and inflation are simply too strong and too high for lower rates right now.
With the outlook changing for Fed policy and amid stubborn inflation, what's likely to happen with mortgage rates this winter? Why not check out our latest Two-Month Forecast for mortgage rates to see what we think.
See our brand-new 2025 Mortgage and Housing Market Outlook, covering mortgage rates, housing conditions, the Fed and lots more.
For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".
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