As mortgage rates come down from 8% closer to 6.5%, the 2024 housing market will see changes in inventory, home prices and sales.----- Transcript -----Jay Bacow: Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of Securitized Products Research at Morgan Stanley. Jim Egan: And I'm Jim Egan, the other Co-Head of Securitized Products Research. Jay Bacow: And on this episode of the podcast we'll be discussing what the recent rally in mortgage rates means to the mortgage and housing Markets. It's Thursday, December 21st at 11 a.m. in New York. Jim Egan: Now, Jay, the last time that we were on this podcast, we talked about what an 8% mortgage rate can mean to the homeowner. Now, mortgage rates have come down. They're getting quoted with a 6% handle. What happened? And where do we see mortgage rates going from here? Jay Bacow: The combination of data and Fed speak made the markets expect a lot more cuts from the Fed in 2024. Markets are pricing in close to 150 basis points of cuts, and that's caused a pretty large rally in rates. Primary mortgage rates to the homeowner are generally based off of secondary mortgage rate execution in the market, along with treasury rates. And you've seen a little over a hundred basis point rally in Treasury rates and a little over 150 basis point rally and secondary market execution. Jim Egan: Okay, So mortgage rates are down 150 basis points. Jay Bacow: Not quite. Lenders don't really drop the primary rate as fast as a secondary rate goes down because they're not going to be able to deal with the added volume of inquiries until they add staffing. So we don't think primary rates are going to come down quite as much as secondary market rates have come down right now. But if rates stay here for some time, then we'd expect mortgage rates to settle in, in the context of about 6.5% or so. Jim Egan: Basically, what you're saying is when originators can hire enough officers to deal with the refinance and purchase inquiries, then they'll drop rates, effectively, don't cut profits if you can't make it up in volume. Jay Bacow: Exactly right. Now, what we would point out is there's only about 5% of the market that has a mortgage rate above 6.5%. So we wouldn't really expect a huge wave of refi activity. But what we would expect is that as market is pricing in more cuts, is that investors are going to feel more comfortable buying mortgages. For instance, right now the yields on mortgages that investors earn is similar to the yield that they can earn with Fed funds. However, the market is expecting that 150 basis point move lower in Fed funds next year, but they're not really expecting the back end of the yield curve to move that much. And so we think that investors like domestic banks, will be looking to move their cash out of the Fed's interest on reserves and into securities, and the probability of that happening is higher now than it was before all these cuts got priced in. But that's sort of investor behavior. What does this rally mean for the housing market writ large, in particular I guess I'm thinking like housing activity. You know, you put out a forecast a month ago. Do we think it's going to pick up now given the rally? Jim Egan: So when we published our year ahead forecast, we were expecting affordability to improve and to improve in line with the decreases in mortgage rates that you were discussing a little bit earlier in this podcast. But if interest rates were to stay here, that improvement would obviously be occurring far more quickly than we had originally anticipated. Jay Bacow: Now, I guess I would think that more affordable housing would equal a higher volume of home sales. But we moved up to that almost 8% mortgage rate so fast and then we've rallied so quickly, and a lot of this happened during this slower seasonal period. So what are you thinking about the implication for home sales in general? Jim Egan: As you're pointing out, it's not really that straightforward here. The affordabi