Factors Influencing Interest Rates in 2024: What Buyers Need to Know

The Wall Street Journal recently addressed a topic at the forefront of many minds: the timing of interest rate adjustments and their repercussions on relocation decisions in 2024. Initial projections leaned towards rate reductions for the year, with even the Fed penciling in three drops. However, mounting uncertainties stemming from elevated inflation levels cast doubt on these expectations. While the Fed's direct impact on rates is limited, there exists a complex link, with Fed rate adjustments having a ripple effect on Treasury rates, potentially influencing 15-year and 30-year rates. With inflation surpassing projections, questions emerge about the likelihood of rate drops. Let’s look at the intricacies surrounding inflation-driven challenges, potential impacts on the housing market, and insights into interest rate forecasts amidst an election year and broader economic dynamics.

Factors Driving High CPI: Shelter and Energy

The CPI data for March stood at 3.5%, exceeding the Fed's target of 2%. The main drivers of this high CPI were shelter and energy.

Shelter accounts for approximately 40% of this category. The high cost of shelter, coupled with housing affordability issues and higher interest rates, is impacting these CPI figures. It's improbable that shelter costs will decrease because despite a decrease in sales by about 11.3% in March, we still observed year-over-year price increases.

Likewise, energy costs are unlikely to decrease due to the current global uncertainty, including ongoing and potential conflicts. Both shelter and energy expenses are expected to remain high. In such a scenario, the Fed typically leans towards maintaining higher interest rates for an extended period.

Inflation Challenges & Impacts on the Housing Market

Inflation is currently above the Fed's desired level. Their target goal is 2%, but personally, I don't believe we'll reach that number. It seems unrealistic due to the high levels of debt in our country and the anticipated deficit spending. Both presidents have engaged in deficit spending, and regardless of who gets elected, this trend is likely to continue. Deficit spending tends to drive inflation, so I doubt we'll hit that 2% mark. The Fed is facing a challenging situation. Lowering interest rates could potentially fuel more inflation by increasing home prices. However, if they refrain from lowering interest rates, it could also contribute to inflation in the housing market.

The reason for this is that many builders have halted their projects due to higher construction costs and subsequently higher borrowing costs. When builders undertake new developments, whether multifamily or single-family, they need to secure construction loans. Currently, many construction loan projects are subject to interest rates between 8% to 10%. For instance, if you aim to construct a $500,000 home with a 10% construction loan, that adds $50,000 in interest to the overall cost of the new home. Interest rates of 10% or 8% create a significantly inflationary environment for new construction compared to rates of 4% to 5%. These costs are factored into the prices of homes.

Additionally, the reduced number of homes being built contributes to a lack of supply in the market. More supply generally enhances overall affordability and helps stabilize prices. With the current shortage of supply, inflationary pressures persist, pushing inflation numbers above the Fed's 2% target.

Interest Rates Outlook in an Election Year

In a normal year, I don't think we see interest rates come down due to inflation being higher than the Fed's target of 2%. However, I do think we should have interest rates come down, probably not down to the 2% or 3% range, but we need to find that sweet spot somewhere in the 4% or 5% range to get more supply introduced into the marketplace. I don't know that the Fed realizes that yet.

In a normal market, I don't think we see interest rates come down, but I still think we have a shot for interest rates to come down in 2024, because this is an election year. You look at something that President Biden recently said. He said, “I'll bet you see those rates come down more, because I bet that little outfit that sees interest rates is going to bring them down,” at a recent campaign rally. I think interest rates could come down due to the election. It's just not as much of a slam dunk as we thought just a couple of weeks ago now that inflation numbers are higher than anticipated.

Forecasting Interest Rate Shifts

Overall, in the next few years, I believe we'll likely see rates remaining in the 6% to 7% range unless the Fed realizes the necessity of lowering rates to increase supply. Without such action, rates could stay in this range for an extended period because these rates are typical historically, not just in the last two decades. Based on the Fed's policy of aiming to reduce inflation to the 2% level, and considering that inflation is staying above that, rates could stay in the 6% to 7% range over the next several years.

After two decades of having lower interest rates, we might be entering a new normal period with the higher debt levels that this country has, deficit spending, and all the money printing that the Fed and the government are doing, and really the additional risk level as well.

Typically, we have ten-year Treasury yields with spreads between the ten-year Treasury and the 30-year mortgage rates of about 1.7%. If a ten-year Treasury is at 4%, you would typically see a 30-year rate of about 5.7%. But right now we're seeing a spread of 3% due to all the risks associated with potential interest rate decreases, war, debt, and everything that's going on in the world. It's really unlikely that this spread comes down very dramatically in the near term.

Another consideration is potential quantitative tightening from the government. They've got a lot of loans on their balance sheet, $2.4 trillion worth of mortgages on their balance sheet, that they said they wanted to offload. They've really kind of stalled that now with interest rates starting to increase. But if they were to start that program back up, that would have a huge impact on interest rates and push them up very quickly as well.

Matt’s Advice

If you're a buyer, you may be wondering what to do. Well, I think you follow the smart money. Investors are buying. Blackstone has been all over the media; not only have they been buying, but they've also been encouraging other investors to look to invest as well because they think the market has bottomed out and single-family home sales to investors have hit a record high. My advice is life continues regardless of the interest rates; job promotions, marriages, babies, and empty nesting. Renting means you pay 100% interest, so if you're a renter, you want to get out of that scenario as well as start to build wealth.

Inflation stayed high due to the housing market and energy. With high inflation, it looks like higher interest rates could become the new normal. Even with that dip of 10.1% in sales volume, housing values have continued to rise. As a result of all that, energy is unlikely to come down with ongoing wars and potential escalation in the Middle East, so waiting for lower interest rates is likely going to cost potential buyers, with both higher prices on homes due to inflation and the lack of supply.

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