Where are mortgage rates headed? What to watch.

Fannie Mae’s 30 year mortgage rates have fallen more than 9% over the past 60 days after hitting a high of 3.84% in mid-March.  This is after increasing more than 20% from early November, just before the presidential election.  So what should we be looking at for 2017 as we try to divine the future of mortgage rates and the potential impact on residential real estate?  We’d focus on three things, in this order.  First, and maybe most importantly, we’d focus on the new administration’s tax, trade and regulatory policies.  Both the equity and long-term bond markets have baked in expectations that the new administration and the Republican controlled Senate and House will reduce corporate taxes (and maybe personal taxes) and reduce or simplify regulations that restrict business.  To the extent these expectations are unmet, we’ll see 10-year treasury yields slide which should push 30 year mortgage rates down.  Second, long-term bond yields are tied to long-term growth expectations.  Watch for weakness (or strength) in employment and inflation numbers.  Mortgage rates are only indirectly influenced by Federal Reserve interest rate policy.  They are much more directly influenced by expected economic strength.  Finally, we would watch what the Federal Reserve does with respect to working down its balance sheet.  During the Great Recession, the Fed’s balance sheet grew to $4.5 trillion from less than $1 trillion.  The Fed has announced its intention to begin to reduce the size of its balance sheet.  This likely will involve some combination of selling assets and simply not buying more of various assets that come due.  This all makes sense.  The Fed needs to work itself back into a position where it has some tools at its disposal to effectively assist during the next recession.  Nonetheless, the pace at which the Fed ultimately moves to reduce the size of its balance sheet will put upward pricing pressure on U.S. Government bonds which should in turn put upward pressure on 30 year mortgage rates.