ERATE® Update: Which Way Mortgage Rates?

by Broderick Perkins

(3/4/2013) - Mortgage rates aren't going anywhere fast.

Mortgage interest rates are inextricably bound, not only to federal monetary policy, but also to both the domestic and global economies that generate consumer confidence - or lack thereof.

Based on current economic conditions, mortgage interest rates could bounce around the 3.5 percent mark for as far out as 2016. During that period, rates aren't likely to see any large swings in either direction.

Rates are however, more likely to trend slightly lower, rather than higher, again, based on today's market conditions.

Should conditions change for better or for worse, all bets are off.

According to Freddie Mac's Weekly Primary Mortgage Market Survey (PMMS) mortgage interest rates have been on the decline since the onset of the mortgage market crash, the housing downturn and the Great Recession that followed.

PMMS reveals, during that post boom cycle, the average annual rate for the 30-year fixed-rate mortgage has been:

• 6.41 percent in 2006
• 6.34 percent in 2007
• 6.03 percent in 2008
• 5.04 percent in 2009
• 4.69 percent in 2010
• 4.45 percent in 2011
• 3.66 percent in 2012

The average rate for the 30-year fixed rate mortgage in January this year was 3.41 percent and February 3.53 percent - about half what it was during boom times.

While general recessionary conditions pushed rates lower in the early years of the downturn, specific economic stimuli by the Federal Reserve have played a large part in further depressing rates and keeping them low through the economy's fledgling recovery.

What the Fed did for mortgage interest rates

Back in December, 2011, according to the Federal Reserve Federal Open Market Committee's announcement, "The Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions - including low rates of resource utilization and a subdued outlook for inflation over the medium run - are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014."

But a year later, by the end of 2012, amid struggling economy growth, the Fed stepped up efforts to spur economic growth by, among other things, beginning to acquire an additional $40 billion a month in mortgage-backed securities while pushing out retaining the low federal funds rate until 2015, .

Most recently, while continuing to both keep the benchmark rate low and purchasing extra mortgage backed securities, the Fed added employment figures and inflation numbers to determine how long it plans to keep benchmark rates low.

"The FOMC indicated that it expects to maintain an exceptionally low level of the federal funds rate at least as long as the unemployment rate is above 6.5 percent, projected inflation between one and two years ahead is no more than a half percentage point above the Committee's 2 percent target, and long-term inflation expectations remain stable," according to one of the most recent statements from Federal Reserve Chairman Ben Bernanke, this during the Fed's annual Monetary/Macroeconomics Conference in San Francisco, CA, March 1, 2013.

Days earlier, Feb. 26, during questioning at the Fed's Semiannual Monetary Policy Report to the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Bernanke gave a "reasonable guess" that the nation won't seen an unemployment rate of 6 percent before 2016.

Economic conditions

The Fed's plan to keep rates low is based on simple economic principles. A low federal funds rate and other efforts translate into low consumer interest rates - especially in the mortgage market. Low consumer interest rates help generate consumer spending. Generate consumer spending - especially in the housing market - and you give the economy a real boost.

Housing, and related expenditures, account for nearly 40 percent of the Consumer Price Index, an index of consumer expenditures, according to the U.S. Bureau of Labor Statistics.

For sure, low interest rates have been key to the current housing recovery, but that hasn't been enough fuel to get the greater economy firing on all and drive sufficient job growth.

A major measure of the nation's economic growth, the Gross Domestic Product (GDP), grew at only an annual rate of 0.1 percent during the October to December period, according to the U.S. Commerce Department.

That's really zero growth, as reflected by the jobs market.

Not only is unemployment down only a half percentage point from 8.3 percent in January 2012 to 7.9 percent in January this year, the unemployment rate - like the economy - is pretty much stuck. The jobless rate has been at 7.8 or 7.9 percent since September of 2012.

Even if interest rates were zero, lenders won't loan money to anyone who doesn't have a job.

As long as the economy grows at a snail's pace and jobs are as rare as endangered species, interest rates will remain low and feel pressure to fall.

And it's not just the U.S. economy. The Eurozone is taking an even bumpier road to recovery and one economy impacts the other.

The European region's economy suffered three consecutive quarters of decline in 2012, ending the year 0.5 percent smaller than it was in January.

Unemployment in the zone, is nearly 12 percent, according to the European Union, with Greece suffering a jobless rate of 27 percent, Spain at more than 26 percent and Portugal around 17.5 percent.

While European investors often flock to U.S. markets during bad times overseas, U.S. exports also take a hit.

Consumer confidence

Back on U.S. soil, toss in gasoline prices $.50 higher since Jan. 1, the average $50 a week lost to the end of the two-year payroll tax "holiday" and lingering fiscal cliff-related U.S. budgetary issues and it's understandable why consumer confidence is in a shambles.

The Conference Board's Consumer Confidence Index came in at 69.6 in February this year, down from 70.8 last year, which was the highest since February of 2011.

Consumer Reports' Sentiment Index, which measures how consumers are doing financially versus a year ago, similarly came in at 48.9 in February this year, down from 49.6 a year ago.

It's tough for consumers to feel confident about spending money when so many uncertain conditions fester.

Even with the housing recovery underway, a major reason there aren't more homes for sale is that property values remain far from peak levels.

As of December 2012, home prices remain approximately 30 percent below their June/July 2006 peaks, according to Standard & Poor's/Dow Jones Home Price Indices.

That means millions of homeowners remain underwater, in negative equity positions with mortgages larger than their home is worth and can't sell.

Not only aren't consumers not spending money on goods and services, most are also not buying homes and that lack of consumer spending adds to the downward pressure on mortgage interest rates.

Current economic conditions are in a sort of Catch-22 holding pattern where economic growth isn't sufficient to give consumers the confidence to spend and the economy can't grow faster without more consumer spending.

Mortgage interest rates hang in the balance.