The Big Picture – April 12th, 2023

Published Abr 12, 2023

“It’s human nature to extrapolate the recent past into the future, but it’s terrible that managements go along with this.”

Charlie Munger

This might sound crazy, but I believe conditions are being set for the “mother of all” purchase markets in our future; perhaps even better than the 2021 market. Let me explain.

The most important gauges of home sales and mortgage activity are at levels so low that they aren’t just below last year, they are far below averages for “normal” pre-pandemic years. In other words, the normal housing activity resulting from natural life events is being ‘pushed’ from the present into the future. The key drivers of future home sales and mortgage activity – housing inventory, risk-free rates, and MBS spreads to risk-free rates – are all at levels that in my opinion, rebalance their risks in favor of outcomes that are very positive for future mortgage rates. And these days, lower mortgage rates not only increase affordability, but also increase housing supply. Here’s a look at how this could come together.

Purchase Mortgage Application Volume

The headlines we see usually compare current mortgage applications to purchase a home with what they were last year. That’s interesting, but what’s more interesting is how they compare to the years leading up to the pandemic and application levels are still roughly 25% lower than 2018/2019 average. In other words, we don’t need a return to 2021 rates to produce a very meaningful increase in mortgage activity. And recent experience shows that applications are extremely sensitive to even modest reductions in rates. People still want houses and lower home prices along with any rally in rates will have an enormous impact on mortgage applications.

Risk-Free Rates

Let’s set predictions aside and think in terms of probabilities. Given recent inflation data, banking system fragility, growing likelihood of recession, mounting geopolitical risks, and the crushing levels of household, corporate, and government debt, I see the probabilities far more weighted toward reductions than increases hereafter. These things rarely happen in a linear fashion, so it could be a serpentine path, but with the risks mentioned above considered together with the fact that yields are well-above the medians of the last decade, it’s not crazy at all to thing that risks have rebalanced toward a rally in risk-free rates.  

MBS Spreads to Risk-Free Rates

But we all know by now that risk-free rates don’t fully explain mortgage rates and the yield spread between MBS and Treasury rates is volatile and responds to different stimuli. A very simple and useful metric is the spread between the current coupon MBS (the theoretical MBS that is always priced at par) and a blend of the 5Y and 10Y Treasury rates (this is the yellow line below). Since last year before rate hikes began and banks began their troubles, this spread has widened more than 50 basis points. That means that with lower market volatility and a bit more confidence that banks won’t be desperation-selling MBS we could see a half a point reduction in rates even if risk free rates don’t drop as well. If we combine a rally in risk-free rates along with some optimism about MBS performance, we see a compounded effect in mortgage rates.

New Listings

Now comes the most shocking perspective: new listings for this past March were nearly 30% lower than the typical pre-pandemic amount for the same month in each of the past 7 years. Much of that decline is due to the “lock-in” effect of owners not wanting to give-up low mortgage rates this Spring. But life goes on and every day that goes by means that demand for any type of housing purchase – a trade-up, a downsize, a move, a first-time purchase – is being postponed. And that means that when rates do come down, both supply and demand will surge.


I’m not suggesting that you cancel the summer vacation to be ready, but I do believe that the relationships you are building now are about to become very fruitful. And it won’t require another national emergency, just a bit of mean-reversion. And if mean-reversion turns into an over-correction, it could be the mother of all markets. Prepare now.


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