As we enter 2H 2023 and head into 2024, I expect mortgage rates will increase and eclipse 8% on average. 

First, I expect the federal funds rate to rise one more time by 25 bps, to continue to rise before settling in what will be a new normal, close to the rate levels we are seeing today. I believe this because this is what the Fed says they are going to do.

Second, I expect inflation to continue to flare up. I believe that too many inflationary pressures remain for the Fed to confidently declare victory in 2024, and there is a ton of risk that these pop up in 2024, derailing investor hopes that they will start dropping rates. We are still seeing 10,000 boomers retiring every day, with not enough workers to replace them (upward pressure on wages). Energy prices are artificially low, and cannot be sustained at this low level for long. Any system shocks spike energy prices, especially oil, and will give the Fed reason to be cautious about lowering rates aggressively. 

Third, while rising rates hurt asset values, I think that it is unlikely that they impact employment, at least in the numbers the Fed will be looking at. Take a $100M apartment building. Rising rates impact it's value, but even if it crashes in value to $80M, you still need property managers, maintenance people, lenders, insurance, and more to run the property. These jobs don't go away. LPs and syndicators lose money, maybe a few analyst jobs at the fund are lost, but fundamentally, a reduction in asset values in this category does not impact employment in a meaningful way. 

And, while there are layoffs happening right now, in the white-collar space, it's estimated that 60M Americans did some form of "gig" work in 2022. This is new for our economy. An estimated increase of +30M from the Great Recession. An uber driver calling it quits does not hit unemployment stats. We also (depending on your source) have upwards of 11M illegal immigrants.  

This is important. No gig jobs lost, and no jobs lost by illegal immigrants, can (by definition) create a spike in unemployment as the Fed tracks it. 

The economy can face disaster, and if the unemployment level does not rise, the Fed will have no catalyst to start dropping rates. They are free to tackle inflation without fear of driving up unemployment in a detectable way. The Fed's dual mandate (keep inflation and unemployment low) is really a single mandate in the current economy. 

Fourth, and as a result of this dynamic, I expect the yield curve to continue uninverting. I expect the market to be forced to agree that the federal funds rate will remain elevated, north of 5%, for some time to come. As a result, the yield curve will continue uninverting (it has been slowly uninverting all year, and is picking up steam in recent weeks). I'd be willing to bet a considerable amount that you will see a 10 year treasury rate north of 5% by middle of  Q1 next year, and won't be surprised if the 10 year goes north of 6%, or even 6.5% sometime next year. 

Fifth, even if I'm wrong and the Fed does start lowering rates, the gridlock in Washington and our ballooning national debt load can cause interest rates to rise, by lowering investor confidence in treasuries. US debt was already downgraded earlier this year. A shutdown in coming weeks will not help the case. I do not think that anyone is likely to start classifying US debt as "junk" in the near future, but I also don't think that it will continue to enjoy essentially "risk free" status in the market. This has huge consequences in driving yields and borrowing costs for the government up. 

Scary thought - all of my previous fears could come true, and US credit can get downgraded again, compounding the rise in rates.

You don't have to think too hard about this one - Fundamentally, do I think that my friend who makes $200K per year, with an 820 credit score, and who owns a nice house with 25% down payment and $750K mortgage collateralized by a property worth $1M is more likely to pay me back over the next 10-30 years? Or do I think that the US government, spending at an annual deficit of +$1.5T annual deficit and $33T in total debt (Annual US revenue is $4.9T so debt is 6.7X total revenue - it's like my friend with a $200K income getting a $1.3M uncollateralized personal loan - backed by his "full faith and credit" - he'd never qualify!), with no collateral besides tax revenue, is a better bet? 

As of 2023, I'm personally picking my friend. Why not? It's literally an option in today's economy to lend to 800+ credit score borrowers putting 25% down at 7.5% interest. 

Want a more liquid option than a single loan? Try a mortgage REIT. Or, try a brand name firm that you can easily understand. Walmart $630B in Revenue, $65B in debt, and $37B in free cash flow. No contest with US gov't.

This is a very real option that the markets have right now. I bet they will start to agree with me in the next few years, slowly, incrementally, and this will put upward pressure on interest rates, by increasing treasury rates as alternatives look more attractive than US debt. 

Why does all of this matter?

This all matters because 30-year mortgage rates (and other commonly used debt products in the commercial real estate space) are highly correlated with the 10-year treasury. As treasury rates tick up, especially the 10-year, so will 30-year mortgages. 

"The Spread" between 30-year mortgage rates and 10-year treasuries will not save mortgage rates: 

 Many pundits are arguing that rates will come down in the coming months for two reasons. 

First, they disagree with everything I said above, and think that inflation will be beaten, a recession is coming, and the fed will be forced to reduce rates. Maybe they are right. You have my argument. 

Second, they argue that right now, the spread between 10-year and 30-year treasuries is relatively high. As of today, 30-year rates for top credit scores are about 7.59%. The 10-year is at 4.61%. That's a difference (or "Spread") of 2.98%. The historical average for this spread is about 1.75%. So, some would argue that mortgage rates will come down by 1.2%. Thus, they argue that rates will come down. 

Fair enough. I do expect the spread to normalize. But, I expect it to normalize in the context of the 10-year treasury rising, not because of mortgage rates falling. The market agrees with me right now (that's why there's a higher than usual spread!) . And the 10-year can rise by a whole lot more than 1.2% in the next year. 

Time will tell, and it will certainly be better for my pocket book and portfolio if I am wrong in this analysis. But, I'm laying my bets on this continuing, and playing defense. I think you should be extremely fearful and skeptical of strategies that rely on rates coming back down in the near-term (next 2-5 years).

This doesn't mean I'm doing nothing. It just means I'm extra cautious, underwriting with current rates, putting more down, and doing a little bit more lending (high rates means higher interest for the lender). 

Hope this helps if you made it this far.