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Mortgage rates are headed back up and applications are down as more inflation data comes in hot, spurring fears of another Federal Reserve rate hike in November and a more hawkish “higher for longer” interest rate policy.

Applications for purchase loans fell last week to the lowest level since 1995, according to a weekly survey of lenders by the Mortgage Bankers Association. The MBA lender survey showed requests for purchase loans fell by a seasonally adjusted 2 percent from the week before and were down 28 percent from a year ago.

Requests to refinance were down 5 percent week over week and 30 percent from a year ago, to the lowest level since Jan. 2023.

Joel Kan

“Both purchase and refinance applications fell, with the purchase index hitting a 28-year low, as prospective buyers remain on the sidelines due to low housing inventory and elevated mortgage rates,” said MBA Deputy Chief Economist Joel Kan in a statement.

It’s an abrupt turnaround from last week, when more encouraging inflation numbers were helping bring mortgage rates down from 2023 highs. The previous MBA weekly lender survey showed homebuyer demand for purchase mortgages picked up during the week ending Aug. 25, the first increase in six weeks. Purchase loan applications had previously dropped to the lowest level since April 1995 during the week ending Aug. 18.

Mortgage rates climbing toward 2023 peaks

The Optimal Blue Mortgage Market Indices, which track daily rate lock data, show rates on 30-year fixed-rate conforming mortgages climbing to an average of 7.15 percent Tuesday, not far from a 2023 peak of 7.30 percent on Aug. 22.

Yields on 10-year Treasurys — a barometer for mortgage rates — are also approaching post-pandemic highs this week as investors react to two reports suggesting that Federal Reserve rate hikes have yet to tame inflation.

On Tuesday, the Commerce Department reported that new orders for factory goods fell by 2.1 percent in July. While it was the first decline in four months, much of the decline was attributed to a slowdown in the transportation sector, and economists had expected a bigger drop.

That news was followed by Wednesday’s release of an index tracking economic activity in the services sector by the Institute for Supply Management (ISM). At 54.5 percent, the ISM Services PMI for August was up 1.8 percentage points from July to the highest level since February. Subindexes tracking employment and prices paid could be of particular concern to Federal Reserve policymakers.

But the ISM’s index “has hugely overstated job growth since last fall,” Pantheon Macroeconomics Senior U.S. Economist Kieran Clancy said in a note to clients. A hiring intentions index by the National Federation of Independent Business has been a better predictor and suggests “a flattening in payroll growth over the next couple months,” Clancy wrote.

It would also be a mistake to give too much credence to the recent strength in spending on services, Clancy wrote, in part because the restart of student loan repayments in October “will deal a meaningful blow to households’ spending power. With that in mind, we think the ISM services index will soon revert to its previously-slowing trend.”

But inflation fears are souring bond market investors on long-term government debt, pushing yields up. Yields on 10-year Treasurys climbed above 4.3 percent Wednesday, up nearly a quarter percentage point from Friday’s low of 4.06 percent.

Having implemented 11 interest rate hikes from March 2022 through July, the Fed has brought its target for the federal funds rate to between 5.25 and 5.5 percent — the highest level since 2001. Now investors and economists are uncertain whether the Fed will hike rates again, or how long it will wait before bringing rates back down next year if the economy slows.

Fed Governor Christopher Waller still hawkish

“That was a hell of a good week of data we got last week,” Federal Reserve Governor Christopher Waller, an inflation hawk, told CNBC Tuesday. But while the positive inflation data means the Fed can afford to take a wait-and-see attitude before hiking rates again, “I don’t think one more hike would necessarily throw the economy into recession if we did feel that we needed to do one.”

Waller also said he’d be inclined to hold rates higher for longer until clear evidence emerges that inflation is in check.

Futures traders see only a 9 percent chance that the Fed will hike short-term rates on Sept. 20, but the odds of a November rate hike are now nearly even, according to the CME FedWatch Tool, which tracks futures markets to estimate the probability of future Fed rate hikes.

The FedWatch Tool shows investors have priced in a 48.5 percent probability of one or more additional Fed rate hikes by Nov. 1. That’s up from 28.2 percent on Aug. 4.

Hopes for spring rate cut fading

Futures markets predict a 47 percent chance that the federal funds rate won’t be any lower by March, and a 31 percent chance that it will be higher. Source: CME FedWatch Tool

Expectations that the Fed will bring rates down in the spring are also fading, with futures markets pricing in only a 22 percent chance that the Fed will start lowering short-term rates by March 20. On Aug. 4, futures market investors saw a 63 percent chance that the Fed would have implemented one or more rate cuts by March.

Regardless of what Fed policymakers decide on future short-term interest rate hikes, the U.S. central bank is expected to continue to trim its massive balance sheet of long-term Treasurys and mortgage-backed securities (MBS).

Fed has trimmed $1 trillion from balance sheet

Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis

The Federal Reserve’s “quantitative tightening” — it’s letting $60 billion in Treasurys and $35 billion in MBS roll off its books each month — means there’s less demand for such investments. Because bond prices and yields tend to move in the opposite direction, quantitative tightening may be helping prevent long-term interest rates from falling.

After going on a buying spree during the pandemic to keep interest rates low through “quantitative easing,” the Fed has trimmed $1 trillion from its Treasury and MBS holdings, which peaked at $8.5 trillion last year.

The Fed’s holdings of long-term Treasuries, which peaked at $5.77 trillion in June 2022, stood at $5 trillion at the end of August, a $764 billion drop. At $2.5 trillion, the Fed has trimmed $241 billion from its MBS holdings, which peaked at 2.74 trillion in April 2022.

At a Brookings Institution panel discussion last fall, Johns Hopkins University economist Jonathan Wright said he was skeptical that the Fed would be able to trim its balance sheet below $7.5 trillion, because of the risk of creating market turmoil that might threaten the Fed’s ability to control short-term interest rates.

“My assumption is that [quantitative easing] will never get reversed, or even largely reversed,” Wright said.

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Email Matt Carter

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