Are We Experiencing “Transitory Mortgage Rates”? What Does That Mean For Rates?

In March 2021, Federal Reserve Chairman Jerome Powell said, “[T]hese one-time increases in prices are likely to have only transient effects on inflation.” From then on, “transitory inflation” became the phrase of the year in economics, with high hopes that once the initial supply chain shocks and government stimulus after the onset of the pandemic wore off, inflation would return to its regular scheduled programming and maybe even deflate.

It turns out, however, that trillions of new dollars in stimulus and slashing interest rates to near-zero for a prolonged period of time did not make inflation “transitory.” Instead, it became a new chapter for the economy.

But in this article, I want to talk about what I’m calling “transitory mortgage rates.”

What Are “Transitory Mortgage Rates”?

Transitory inflation is defined as an inflation rate that moves above its typical rate for a short period, with the expectation that the rate will revert back to its typical rate. It’s the opposite of persistent inflation, which is what we’ve experienced over the last two years and forced the Fed to raise interest rates in the manner that they have.

Mortgage rates, while highly influenced by the federal funds rate, are subject to their own fluctuations and usually follow the trajectory of bond yields. With that in mind, how could they be in a transient state right now?

Given that the federal funds rate has remained at 5.25-5.5% for the last few months, and the average 30-year mortgage rate has decreased by over 1% since October. By the transitory definition, mortgage rates are reverting to their base naturally after a period of higher rates. Add in that the higher-than-normal spread between bond yields and mortgage rates has also started to decline, and there might be some runway for mortgage rates to keep decreasing even without the Fed cutting rates.

By how much, though? 30-year mortgage rates tend to be within 1-2% higher than 10-year Treasury bills. Today, the spread is around 2.7%. While there are a number of factors that influence the spread, if we’re looking at this from the most basic of lenses, it could mean that there’s still room for mortgage rates to fall anywhere from 0.7% to 1.7% without lowering the federal funds rate. If that were the case, then the current 30-year mortgage rate average of 6.67% could drop to as low as 5%. 

If we look at the decade leading up to 2020 and the pandemic, the average 30-year mortgage rate ranged between 3-5%. If mortgage rates were to continue falling and revert back to their typical spread, then it would effectively be a “transitory mortgage rate.” A rate that was higher than its base rate for a short period until it naturally reverted to its base. 

Does This Change If The Fed Will Lower Rates?

Low interest rates are great for expansion, but economies run the risk of overheating with prolonged easy money policies. Inflation increased at a ridiculously high rate for the greater part of two years. We saw home prices reach record highs, gas prices rise, costs in grocery stores rise, and more. In short, whether mortgage rates drop organically or not, it doesn’t change the Fed’s decision-making. They’re looking at inflation and unemployment.

While the Fed was late to the party in raising the federal funds rate, the hikes were necessary to defeat inflation. The latest inflation data shows that personal consumption expenditures (PCE) dropped to 2.6% in November, which is great progress, but would a premature rate cut make that number tick back up? 

The Fed has to make a decision in 2024. They either let rates stay steady and risk a slowdown that’s more painful than intended. Or lower rates and risk overheating the inflation rate all over again. The latter is easier to stomach but certainly a concern. The Fed would be happy to see the mortgage rates fall on their own, but it’s also important to keep in mind that the sole purpose of the Fed is to control inflation and unemployment, not the cost of housing.

For us, lower mortgage rates and low inflation are a good combination. If the Fed can hold off from lowering rates and keep inflation controlled while we continue to see a decline in mortgage rates, then there’s not much to complain about. We’ll just have to see what happens.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.