Is a soft landing bad news for homebuyers?

Imagine the following scenario a few years ago:

Inflation will reach its highest level in four decades. This will force the Fed to raise rates from 0% to 5%+ in a hurry. Inflation will eventually return to target, but a recession is not why. By the time the Fed is ready to start cutting interest rates, the stock market will return to all-time highs. Also, gold. And housing prices.

It sounds incredibly implausible when you think about it.

However, this happened!

How about this one for you:

Mortgage rates fall to generational lows during a pandemic after the Fed cuts rates to zero and begins buying mortgage-backed bonds. Remote work and the unintended consequences of the pandemic are driving home prices higher for a decade as people frantically search for a new home. After the Fed raises rates, 30-year mortgages go from sub-3% to 8%. House prices are not collapsing. In fact, they are rising to new all-time highs after a brief decline.

It’s funny because it’s true.

The hope now is that the Fed will cut rates to make mortgages more affordable to open up some activity in a housing market that has slowed to a crawl.

All the home buyers who have been on the sidelines for the past couple of years would welcome this development.

But if the following happens:

Rate cuts slow labor market weakness. The soft landing is cemented and the economy keeps going. Short-term rates are falling, but medium- and long-term yields are stabilizing or may rise slightly. Mortgage rates aren’t falling as much as homebuyers would like. Housing prices are not getting any more affordable.

Bloomberg’s Conor Sen argued this week that we either get 4% mortgages from a recession or a stable economy, but not both:

Markets and the Fed now agree that, in a “soft” economic landing, the federal funds rate is likely to eventually fall to around 3%, well above pandemic-era levels. That limits how far mortgage rates can fall — particularly in the run-up to next spring’s housing season — after falling to 6.15 percent from 8 percent in 11 months. Those hoping to go much smaller should be careful what they wish for: A world with substantially lower mortgage rates is one with substantial job losses.

Just look at bond yields since the Fed announced the rate cut – they won’t go down.

On the one hand, a strong economy is preferable to a recession with job losses.

On the other hand, unless mortgage rates fall much further from their current level of 6.2%, there will be many unhappy home buyers.

You can see that the average mortgage rate is still well below current levels (via WSJ):

It would probably take a recession to get anywhere near the 3.9% average rate that current owners are sitting on.

Is there any way to avoid a recession? and get much lower mortgage rates?

It would be nice if we could see the difference between the 10-year Treasury yield and compressed mortgage rates:

It’s about as high as it’s been this century.

The hope would be that we will see this spread return to pre-pandemic norms. Perhaps Jerome Powell could threaten to have the Fed buy more mortgage-backed bonds just to be safe.¹

Besides, it looks like a soft landing won’t help homebuyers much,

I could be wrong, of course. Things could turn out differently. Maybe buyers will step in to buy mortgage bonds and rates will come down. Inflation may continue to fall, but the economy continues to grow and the returns are coming.

Or we finally have that ever-elusive recession and get 4% mortgage rates again. That’s not great for those who lose their jobs, but potential homebuyers who keep theirs would welcome lower borrowing costs.

It feels like we’re in a damned if you do, damned if you don’t housing market.

The Fed can’t magically create more houses to fill the deficit we have. Lower loan rates would help, but there is no panacea that will fix things overnight.

If we’ve learned anything this decade, it’s that economic and market relationships don’t always make sense.

Home prices could fall. So could mortgage rates.

But from where I sit, if we continue in a soft landing zone, it’s hard to see housing getting much cheaper than the current nosebleed levels.

If the recent past is any indication, I’ll probably be wrong.

Further reading:
Who is to blame for the broken housing market?

¹In fact, I think the Fed should do this to help the housing market thaw.