Everyone’s talking about the huge fiscal stimulus package just enacted by Congress and the White House. At $2 trillion, it represents 10% of the total U.S. economy and is the biggest bailout in history.
But there’s an unappreciated source of powerful stimulus that we think will take effect over time. It’s a sort of long-acting medicine in the economic body: much lower mortgage rates. Falling mortgage rates make homes more affordable and put money back in homeowners’ hands.
The U.S. stock market put together an historic rally on Tuesday, March 24, in the wake of the announcement of $2 trillion in stimulus agreed by Congress and the White House. And just a few days earlier, the Federal Reserve (Fed) said it would do whatever it takes to support financial markets, committing to open-ended buying of Treasury bonds, mortgage-backed securities and corporate debt. News of all that stimulus kicked off an historic stock buying spree.
Yet, it was the Fed’s decision to slash interest rates and intervene directly in bond markets that may lead to much lower mortgage rates over time. It works like this—the Fed’s actions bring down U.S. Treasury bond yields, which, in turn, influence borrowing costs on a range of loans. The net effect is that lower Treasury yields mean consumers are likely to enjoy much lower rates on mortgages.
Every 0.25% drop in mortgage rates typically reduces monthly mortgage payments by 3%. Mortgage rates could fall 1% to get back in line with the drop in Treasury yields. A decline of that magnitude would mean 12% lower monthly payments.
Next, let’s assume homeowners pay one-third of their after-tax income on their mortgage. A wave of mortgage refinancing at those new, lower rates could be equivalent to an increase of 4% in income for the average American homeowner.
While stock and bond markets are in epic motion right now, mortgage and other lending rates adjust more slowly. It may take some time before those effects work their way through the financial system and reach consumers.
To date, banks have not lowered mortgage rates, even though Treasury yields have fallen (see the graphic below). Indeed, an imbalance in loan supply and demand means mortgage rates actually increased; mortgage companies are having a difficult time processing the huge volume of loan applications.
The good news is that mortgage rates should eventually resume their historical relationship with Treasury yields. This gap is more likely to close by mortgage rates falling, rather than Treasury yields increasing. That’s because the Fed is committed to buying bonds as needed to keep those rates low. When the effects of lower interest rates fully hit the mortgage market, many homeowners may be able to refinance into much lower payments. This means more money in consumers’ pockets, potentially representing massive stimulus loaded into the system.
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