The Warsh Effect on Mortgages

0:00James Egan:Welcome to Thoughts on the Market. I'm Jay Bacow, Co-Head of Securitized Products Research at Morgan Stanley.

0:06Jay Bacow:And I'm Jim Egan, the other Co-Head of Securitized Products Research at Morgan Stanley.

0:10James Egan:Today, the glow has maybe worn off the championship of the Knicks, so we can talk about the impact of Warsh on the mortgage and housing market. It's Friday, June 26th at 10 a.m. in New York.

0:24Jay Bacow:If we have to stop talking about the Knicks, we can stop talking about the Knicks. But Jay, I think one of the things, if we take a little bit of a step back in mortgage markets, in housing markets, in fixed income markets more broadly, from the beginning of the year to now, we've gone from the market pricing in two and a half cuts from the Fed by the end of 2026 to the market pricing in roughly one and a half hikes, a hundred basis point difference in market expectations over the course of the past five and a half months. Now, that's happened at different times with different levels of velocity and severity.

0:57Jay Bacow:But one of the key talking points we have now is we have a new Fed chair. We had the first FOMC meeting and his press conference after that last Wednesday. What do you think that means for mortgage markets, for volatility? How are you thinking about this?

1:11James Egan:Well, Jim, it's a great question. And we've got asked that by a number of different investors. Chair Warsh has been pretty clear that he thinks people should do more of what they're good at and less of what they're not good at. And so he's felt like the Fed should keep their communication on future guidance relatively short. And so with less forward guidance from the Fed, the market has more uncertainty and more uncertainty translates into more volatility. And more volatility is generally bad for the mortgage market, given that investors are short the option to the homeowner to refinance. Furthermore, shifting from expectations of the Fed cutting to expectations of the Fed hiking generally makes it a little bit less favorable environment for investors like banks and overseas investors to come to the mortgage market.

2:03All right.

2:04Jay Bacow:Now, we've been on this podcast several times this year where we've talked about, you mentioned banks, we've talked about deregulation. We've talked about Fannie Mae and Freddie Mac, the GSEs, them buying mortgages, that being constructive for our mortgage view. Is that still the case, or how are you layering that into your thought process now?

2:22James Egan:That's definitely still the case. Those things haven't changed. The deregulation is still flowing through the markets. That longer term should be supportive of bank demand and aggregate, although obviously there are a number of different regulations going through. The GSEs are still forecasted to buy 200 billion mortgages on behalf of President Trump's initiative. So that's why we're just sort of tactically negative. Those technicals are very strong in an environment where there really has not been much supply. Now, some of that supply is because mortgage rates are still in the context of 6.5%.

2:55James Egan:Some of that is because with mortgage rates at 6.5%, there hasn't been that much housing activity. So Jim, turning it to you, what is the outlook for the housing market in a world where they are expecting the Fed to hike and rates to stay elevated. Right.

3:13Jay Bacow:So the main thing that we focus on from a housing market perspective is less specifically Fed action and more the five and 10 year part of the curve. So when you start to say something like your tactically negative mortgage backed securities here, how can I interpret that from a mortgage rate perspective?

3:29James Egan:If we're tactically negative, it's more of a small move than some massive move. And as you said, and we've talked about on this call beforehand, realistically, the mortgage rate is a little bit less dependent on the Fed policy rate and more around the belly of the treasury curve. And what's going to happen with the belly of the treasury curve is going to be dependent on sort of market expectations along with what's happening in the geopolitical situation. So realistically, if you've written down that the mortgage rate is 6.5 % right now, our view probably doesn't change things too much.

3:59Jay Bacow:And if that's the case, then affordability in the housing market, as we've been talking about, is going to continue to be challenged. And what we think that means from a housing activity perspective is any upside that we really thought would have been there gets pretty significantly capped. But the same side of this token or the other side of this token, if you will, we do think that the current level is well supported here. There's some level of housing activity that has to occur regardless of where affordability is. And we think we found that. We're at 40 year lows from a turnover perspective.

4:33Jay Bacow:From the fourth quarter of 2023 through now, we've been roughly at the same level. That's 11 consecutive quarters now. We think this is the kind of base level for people that need to transact regardless of where mortgage rates are. So the more that the rate environment remains challenged, the more that we kind of hang in this low to mid 6 % mortgage rate environment, we just think that that continues to curtail upside. So it's a housing market and a housing activity space that continues to very much just remain stuck in neutral.

5:03James Egan:All right, so if we're in this new environment and the Fed might be hiking, it's not great locally for mortgage valuations. Housing market more broadly, probably kind of stuck in neutral here. Jim, always a pleasure speaking with you.

5:20Jay Bacow:And always great speaking to you too, Jay. And to all of our regular listeners, thank you for adding us to your playlist. Let us know what you think wherever you get this podcast and share thoughts on the market with a friend or colleague today. And go smash that subscribe button. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you. Smash. Smash. Smash.

5:54James Egan:Back out smash. Can we smash pumpkins? Tonight.