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What will happen to mortgage rates now that China and the U.S. have made progress in their trade war, agreeing to a 90-day period of lower tariffs? Stocks are up considerably this morning and bond yields have also increased. This raises the question: Is the de-escalation of the trade war good for mortgage rates? The trade deals are just one factor, but I see three possible scenarios for mortgage rates in this environment.
First, let’s start with my 2025 forecast for mortgage rates and the bond market, where I anticipated the following ranges:
- Mortgage rates will be between 5.75% and 7.25%
- The 10-year yield will fluctuate between 3.80% and 4.70%.
So far this year, the 10-year yield has ranged between 4.80% and 3.87%, if I count after-hours trading. Mortgage rates have stayed between 7.25% and 6.55%. While my 10-year yield range has stuck for most of the year, the chaos from Godzilla tariffs has impacted the bond market, mortgage spreads and the economy.
Now let’s take a look at the three possible scenarios for mortgage rates given a more stable economic environment.
1. We avoid a recession and mortgage rates stay elevated
If the trade war calms down and we manage to avoid a recession, is that bad for mortgage rates? The answer is yes. If the economy is not headed for a downturn, considering the current Federal Reserve policy, mortgage rates could remain elevated, ranging between 6.75% and 7.25% in 2025.
The 10-year Treasury yield has dropped significantly in recent years when the bond market anticipates a weakening economy, often in anticipation of Federal Reserve rate cuts. We observed this trend again this year when the 10-year yield fell below 4%, even though current economic data did not support such a decline. The market nonetheless believed the economy would weaken.
Generally, it’s a great thing for the country not to go into a recession, but a strong economy is bad for rates. Currently, the 10-year yield is up a few basis points due to the news with China and is trading at 4.44%.
2. Mortgage spreads improve
Assuming my 10-year yield channel sticks, mortgage spreads should behave better, which will help with mortgage rates staying in the 2025 range we have seen between 6.55%-7.25%. After the Godzilla tariffs, the market went nuts; when that happens, the mortgage spreads tend to worsen. This added a 0.10% to 0.25% increase to mortgage rates during the past few weeks. Mortgage spreads have improved, as you can see in the chart below.
If we see more trade deals getting done, the Fed could continue with the two rate cuts they had discussed in 2025 without the labor market breaking, and the year looks the same as it would have without so much tariff drama. As long as the labor market doesn’t break, the Fed won’t get aggressive here with their inflation expectations due to the size of the tariffs.
This will be a big tug of war on the economic data. Can the U.S. economy keep expanding with the tariff percentage higher this year than last, less government money being spent into the economy and the firing of federal workers? This backdrop continues what we have seen all year, so more of the same.
3. The economy doesn’t hold up and the Fed gets more aggressive
Suppose the economy weakens further while more trade deals are being made. In that case, the Federal Reserve may adopt a more dovish stance and cut rates more than the two rate cuts forecasted for 2025. They might believe supply shortages and higher prices are temporary and will eventually decrease, leading them to focus on their dual mandate and adopt a more dovish tone.
If the labor market deteriorates, the Fed may shift its discussion from neutral interest rates to accommodative rates and actions. This backdrop would create a more favorable environment for them, especially if trade deals are finalized and more certainty around trade emerges. As a result, reaching a 6% interest rate may become more achievable.
Jobless claims data, while off the cycle lows, have not indicated a recession in the labor market yet.
Conclusion
We are not entirely out of the woods with the economy yet. However, the more trade deals we finalize and the greater certainty we establish with businesses, the more favorable it is for the U.S. economy. But good news for the economy might not be great for housing and mortgage rates can stay elevated in this environment. As we can see in the chart below, housing tends to do better when a recession starts because rates tend to fall, and home sales have already fallen from higher mortgage rates.
When it comes to mortgage rates, I’m adhering to my forecast model for 2025. If the Federal Reserve is compelled to cut rates further, we could see mortgage rates drop to the lower end of the range. Conversely, if inflation remains stubborn and it takes longer to stabilize prices while the labor market holds steady, rates could stay at the upper end of our forecast. For the remainder of the year, it is crucial to closely monitor all economic data to identify potential issues and stay informed about developments in the trade war.
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