As expected, the Federal Open Market Committee (FOMC) lifted the target federal funds rate to between 0.5 and 0.75 percent. The move was so highly anticipated that the market priced in the increase during November. Over the past few years, the equity markets would freefall at the mere suggestion that the Fed would begin to normalize policy, but the post-election rally has muted market anxiety. In fact, the 10-year Treasury rate is up 65 basis points since the election, which suggests the bond markets are moving well ahead of the Fed.
However, history paints a different picture. Entering today, the spread between the rates was approximately 200 basis points, matching the average spread over the past three years. This suggests the market was undervaluing Treasuries during 2016 due to global influences. Namely, weakness in emerging economies and Brexit applied downward pressure on the risk-free rate. Since the Fed dropped rates to “zero-bound” in 2008, the average spread has been even higher at 230 basis points. All of this suggests that market pricing has returned to normal. Next year, we expect the Fed to raise the 10-year rate three times to a target range between 1.25 and 1.5 percent.
Investors, Traditional Home Buyers Brace for Higher Mortgages in 2017
For real estate investors, higher interest rates have already arrived, and the cost of capital is expected to continue rising through 2017. This could motivate investors anxious about purchasing single-family rentals (SFRs) to move sooner rather than later. Since the week of the election, average 30-year mortgage rates from Freddie Mac for owner-occupied homes have climbed 60 basis points to 4.1 percent. Investors typically acquire loans at a 50- to 75-basis point premium from the agencies. Overall, higher interest rates will continue to put downward pressure on the homeownership rate as first-time buyers are priced out of the market. Sufficient rental demand will enable property managers to lift rents in virtually every major and secondary metro nationwide, except for the most heated housing markets and in markets where apartment construction is robust.
By Steve Hovland, Director of Research for HomeUnion
HomeUnion is an online real estate investment management firm.
