The Fed is likely to pause on rate hikes at next meeting, MBA says

The Federal Reserve is not going to be in any hurry to drop short-term interest rates right now. If anything Mike Fratantoni, the Mortgage Bankers Association's chief economist, expects a pause at the next Federal Open Market Committee meeting in the rate hike cycle.

"It is very, very difficult to try to tease out a consistent message from Federal Reserve officials right now," Fratantoni said during a general session at the MBA's Secondary & Capital Markets Conference. "If you listened just over the past couple of weeks, you've had some more hawkish folks out there saying 'I don't think we're done yet and I think we need a couple more hikes, I'm not happy with all this talk that we're going to pause at the June meeting.'"

But Fratantoni believes Powell is not as inclined to keep raising rates. In a recent conversation with one of his predecessors, Ben Bernanke, Fratantoni interpreted Powell's remarks as "essentially he's looking for a cause, he's going to have to be convinced to increase rates."

Fratantoni is holding to his prior expectations of a recession later this year, but it's possible it could be deeper than he previously thought. This is in contrast with Fannie Mae's outlook of a modest recession.

During the question and answer period, he was asked what would happen with housing if the country did not go into recession. Better economic tidings would not cure the biggest overhang on housing right now, which is and is likely to remain, the lack of inventory, Fratantoni explained.

In making its forecast, the MBA's baseline case does not include a U.S. default on its debt because the ceiling fails to get raised. The biggest risk from defaulting would be another sovereign downgrade for the government, Fratantoni said.

In its forecast, the MBA continued to expect 2023 originations in the range of $1.81 trillion, virtually unchanged from April and a 20% year-over-year drop, as the purchase market, especially the existing home sales side, is affected by the limited inventory. He projected an 18% decline in existing home sales.

But mortgage volume should rebound next year as the purchase market picks back up. Forecasts for 2024 and 2025 were unchanged from April.

"Really motivating that, [is the] thinking that more and more people are going to get married, are going to have children, are going to get divorced, are going to get new jobs," Fratantoni said. "These were not financial reasons to move and need to list a home." That could help alleviate the inventory issues.

Fratantoni expects the spread between the 10-year Treasury yield and the 30-year fixed rate loan to remain relatively wide at around 300 basis points (the last MBA Weekly Application Survey pegged this at 310 basis points), before falling to 250 basis points by the end of this year. A normal spread is between 150 and 200 basis points.

Speaking about the current spreads between the primary and secondary market mortgage pricing, Nicholas Maciunas, executive director in the mortgage-backed securities research team at JPMorgan Chase, noted that typically they aren't as wide as they are now, "unless we're in the middle of some kind of crisis like 2008 [or] COVID."

Driving this is the fact that the Fed has been heavily involved in the mortgage market for the last 15 years. Because of quantitative easing, the banks have needed to find assets to support their deposits and that involved buying MBS.

While the story about the recent banking crisis has been that it was driven by MBS investments, it was really that those failed institutions mismanaged their duration risk, Maciunas said.

When it comes to MBS, bank "money managers still have to buy pretty much everything that's coming out," Maciunas said. "They demand wider spreads typically and they're comparing mortgages not to cash or treasuries, but they're comparing it to buying corporates [versus] other assets, so they're looking at relative value."

The recent debate about loan level pricing adjustments "haven't been nearly as interesting to us as maybe they have been to Congress or the general press," Maciunas said. The one thing beneficial to MBS valuations is that they created a level of "trifurcation on purpose," allowing a look based on whether the loan was for purchase, rate and term refi or cash-out.

Last October, MBA economists said that 30% of capacity needed to be taken out of the mortgage industry. Right now, it is down 19% to 20%, Fratantoni said.

Even with some announced layoffs that have not yet been captured in the data, more capacity likely needs to be removed so the industry can return to profitability, referring in part to the recent data release from the MBA that showed lenders reporting a net loss of $1,972 per loan originated, or 68 basis points, in the first quarter.