We all know the new home market adds a great deal of volume and revenue to the construction materials industry, and that new-housing activity has been in a moribund state for years now. Stubborn inflation, exacerbated by the recent shock of high oil prices, has kept the Fed from easing on interest rates. And quite the opposite; rates recently ticked up a quarter-point—and it appears there is more to come.
At press time, rates for a conventional 30-year mortgage were well north of 6 percent. And what is the outlook over the next five years? Well, forget the 2.5 percent and 3 percent rate loans of the pandemic vintage, because those are gone—and forever. The fact is that smart forecasters watching the Fed and the mortgage debt market see little relief over the next five years.
RATE-YIELD SYMMETRY
One of the most useful indicators for predicting mortgage rates is the yield on the 10-year U.S. Treasury note. Mortgage rates and 10-year Treasury yields typically move in the same direction, although mortgage rates are usually higher because lenders factor in additional risks. This difference is known as the spread. With that in mind, the first step is to look at where economists believe Treasury yields are headed over the next five years. Some economists predict that stronger inflation, coupled with solid payroll growth, will likely cause the Federal Reserve to raise interest rates again by the end of this year. Others expect the Fed to announce a rate cut before the end of 2027, as they believe oil prices will move lower next year, which will cause inflation to move lower on a sequential basis.
It is instructive to note that the yield on Treasury notes drives mortgage rate spreads. The difference between the 10-year Treasury and 30-year fixed mortgage rates has been on either side of 2.5 points in recent years. That is a significant change when compared to the spread from 2010 to 2020, when it was under 2 percent (and often near 1.5 percent). By way of further illustration, as of mid-September, the 10-year Treasury yield was 4.88 percent, and the 30-year fixed mortgage rate was 6.76 percent. The spread was 6.76 – 4.88 = 1.88 percentage points. And forecasts point to somewhat higher long-term yields, as some economists expect the 10-year Treasury to rise over the long term to 4.5 percent by 2035. The Congressional Budget Office (CBO) sees it a little differently, projecting that the 10-year Treasury yield will reach 4.1 percent by the end of 2026, rising gradually to about 4.3 percent by 2030.
One research firm recently published a best and worst case or “bull” and “bear” forecast, which straddles both sides of the crystal ball. The bull case is a soft landing. In this scenario, the Fed successfully guides inflation back to 2 percent without a hard recession. Fed rate cuts resume through 2027-2028, pulling the 10-year yield toward 3.30 percent. The mortgage rate spread narrows to 1.75 percent by 2031. The 30-year mortgage rate falls to approximately 5.05 percent by 2031, meaningfully lower than today but still well above the pre-pandemic era.
The bear case is persistent inflation and fiscal pressure. Here, the prediction is that inflation remains above 2.5 percent, fiscal deficits expand, and foreign holders reduce their Treasury exposure, pushing the 10-year yield above 5 percent. The spread widens to 2.40 percent as mortgage volatility rises and private investors demand greater yields. The 30-year mortgage rate breaches 7 percent in 2027-2028, easing only marginally to 6.90 percent by 2031 as conditions stabilize.
Even in the bull case, mortgage rates are nearly double their pandemic lows and won’t ever fall to those levels again. So, are you waiting for rates to come down to buy that new house? Forget it. Step out now and buy what you can afford, because high rates have no practical end in sight.