Who even thinks about mortgage rates when you think about the financial
markets? These days, it's about tech, crypto, meme stocks. Yet, mortgage
rates could be where the action will be in 2025. It'll be an interesting
year for sure, though. A new U.S. president, some big Fed decisions to be
made, and we're heading into year three of the bull market, which
historically shows us, on average, a bit lower return. So, what better way
to anticipate all of it than to look at the most forgotten corners of the
market to maybe squeeze out some extra returns?
We'll confine it to the U.S. market. First, let's take a look at what the
average fixed mortgage rates have been up to these days.
Both the 15- and 30-year rates rose spectacularly back in '21 and '22 but
have since been relatively stable. Now the opportunity comes from the
possibility that the mortgage rates might (or at least, they should...)
start pulling back a little to the more familiar levels we've seen in the
past 20-25 years. Why is that? Well, first, we'll take a look at what drives
these mortgage rates.
The biggest influence on mortgage rates is what the longer-term Treasury
yields do. Mortgage lenders obviously use the yields as benchmarks to set
their own rates. So, if yields rise, then mortgage rates do the same. Now,
the bond yields are influenced by the suits at the Fed. Sure, they set the
short-term rates, but these indirectly influence the longer-term rates as
well due to expectations set by the Fed. Couple this with easing or
tightening policies, and the Fed has an indirect influence on mortgage
rates. And last but not least (to keep this post within confines),
inflation, or its expectation, is also a big driving factor. High levels of
inflation erode those mortgage payments, their future values, to be precise.
The higher the expected inflation, the higher those mortgage rates become to
compensate. We can combine these into a nice chart to give a better overview
of the relationships, which you can consult below.
So, if we're being really honest here, it all comes down to the Fed and what
they plan on doing. Obviously, they'll look to react based on some of their
own indicators. Yet, we can kind of assume they'll continue to cut rates,
especially given the chances of a recession looming are quite large due to
yield inversion, Trump tariffs, etc. They'll want to front-run the
possibility of a recession to prevent such a thing from being too rough on
our pockets, or so they say. The biggest reality supporting our thoughts is
that this spike in mortgage rates shouldn't even have happened in the first
place. So, this disconnect is an important factor to take into account.
We can sit and discuss all this for hours on end, but how do we actually put
this into actionable ideas as investors or traders? Well, the primary
methods are through Mortgage REITs; companies that invest in real estate
through mortgage-backed securities or directly via mortgage loans rather
than owning physical property. One major factor as to why they're the big
beneficiaries? They often hold fixed-rate MBSs, so when the fixed rate
declines, the values of the existing MBSs increase substantially. A bunch of
other factors, like a cheaper borrowing rate for potential new homeowners,
come into play, but we'll keep it short. Take a look at the mortgage rate
and the industry indices for mortgage REITs below.
And here are some possible REITs that we could take a deeper look at if the
decline in mortgage rates does occur: Dynex Capital, Redwood Trust, and many
more that aren't shown.
The opportunities aren't limited to REITs. Take a look at Rocket Companies,
a financing company moving inversely with mortgage rates too. There are a
bunch of stocks you can use to play the mortgage rate story, like insurance,
home construction, etc.
So, what do you think? Are mortgage rates finally dropping in 2025? Or is it
the case that rates will continue to climb even higher?
Let us know!