Monday Market Update

Mortgage Rates Pt 1: What was missed in the 2014 Forecast?

   

One of the most noteworthy forecasting miss-steps of 2014 was a doozie – almost every economist/analyst in the business thought that rates in general, and mortgage rates in particular, would be higher in 2014 than they were in 2013. The rationale behind these forecasts was fairly straight-forward. First, the Fed had announced at the end of 2013 that it deemed the economy strong enough to begin to “taper” or gradually end the bond-buying program known as Quantitative Easing (“QE”). Less demand would translate into lower bond prices and higher yields. And in fact, the “threat of a taper” in mid-2013 had sent rates up by 1% over that summer as the markets anticipated the Fed’s actions. So forecasters were fairly confident that the only rates place rates had to go was up. For example, the MBA projected that the 30-year fixed rate mortgage would end the year at 5.1%. The C.A.R. forecast in October 2013 said that the year-end rate would be 5.3%. The Freddie Mac actual end of year 30-year rate was actually 3.87

What happened? Well, several things: First, despite months of tapering leading to the end of QE in October 2014, the demand for US Treasuries and mortgage backed securities remained strong throughout the year. Political instability around the globe sent cash into the US as the demand for safety outweighed just about everything else. No shortage of capital, no upward pressure on its price. Yields of US Treasuries and mortgage bonds backed by the government (Fannie, Freddie, FHA and VA) fell. And as we look into 2015, it seems reasonable to assume that this flight to safety will continue as geo-political tensions intensify.

Second, growth in 2014 was uneven in the US and sluggish in many other parts of the world. Europe continues to struggle on the brink of recession and Japan and China are also experiencing slow growth. In the US the second half of the year was stronger than the first, which included and actual contraction in the first quarter as the result of frigid weather, but the overall growth rate for the year was 2.4%, hardly a boom. IN addition, the unanticipated and significant drop in oil prices moderated price gains even more than their slow path and inflationary pressures remained well at bay.

Third, as seen in the following chart from the Philadelphia Fed’s survey of Forecasters, there does appear to be, at least in the last 10 years or so, a bit of a forecasting bias in favor of rising rates. And there is no doubt that the consensus forecast more often than not is a “straight-ruler forecast”, in large part because the “black swans” that end up de-railing the most rigorous forecast are unknowable at the time it is made.

Finally, some have mentioned the possibility of “secular stagnation”; where there simply is not enough investment demand to absorb all the available capital from households and corporations. With the growing ranks of retired baby boomers and their nest eggs, corporate profit gains from equity growth along with the rapid growth of Chinese millionaires, perhaps this argument deserves a closer look.

When all is said and done, perhaps the most important question remaining is why, with mortgage rates remaining at historic lows, has the homeownership rate slipped to a 20 year low? That will be the subject of a future post.