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Mortgage rates have reached the highest level in over 20 years, sparking some concern about the sustainability of today’s housing demand.

Home builders continue to be in a strong position, representing 33% of total inventory and offering consumers funds to help with current affordability levels. Even so, higher rates are weighing on many buyers.

In Zonda’s mid-month builder survey, builders in August mentioned a shift in consumer sentiment given higher rates. Comments include:

  • Funds to close and monthly mortgage payments are much higher than many buyers can handle.
  • The market is slowing down.
  • There still is strong interest, but financing is the main issue.
  • Spiking rates are causing some people to pause.

The comments make sense given the typical monthly mortgage payment is now 73% above where it started at the beginning of last year. While some buyers can, and are, continuing to buy, higher rates are adding to the strain on many would-be home buyers.

Three main reasons are behind the rapid increase in mortgage rates:

1. Realization of higher-for-longer rates. We wrote in June about how the Federal Reserve has three options for its next policy move: hike, pause, or cut. Some investors expected that the Fed would start cutting rates later this year as the economy slowed. However, that slowdown has yet to materialize—quite the opposite, in fact. The Federal Reserve Bank of Atlanta has a real-time economic indicator designed to predict the quarterly data release of gross domestic product. The latest read has third-quarter GDP estimated at an extremely robust 5.9% growth.

Further, the minutes following the most recent meeting of the Federal Open Market Committee (the group responsible for making decisions about rates and monetary policy) highlighted policymakers’ continued fear of inflation. The minutes included a line saying, “With inflation still well above the Committee’s longer-run goal and the labor market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy.”

The economic data, combined with the comments from the Federal Reserve, has led many investors to believe rates will be higher for a longer period of time to cool the economy and further rein in inflation.

2. Funding the federal government’s obligations. The Treasury is increasing its bond issuance to help fund debt payments. According to Business Insider, “The Treasury will issue $1 trillion of bonds this quarter alone, and another $852 billion next quarter, as federal budget deficits deepen.”

There’s often an active market for safe government bonds, but with the Federal Reserve stepping out as a main buyer and the supply increasing, there’s a mismatch between supply and demand. Bond prices and yields have an inverse relationship where lower bond prices are accompanied by higher bond yields. That is what we are seeing today to help entice investors.

3. Change in international appetite. Roughly 30% of U.S. bonds are held outside the country, led by China and Japan. These countries have had a healthy appetite for U.S. bonds until recently; the shift is based on idiosyncratic reasons. In China, there is a focus on investing locally to help revitalize the domestic economy, which is decreasing demand for U.S. bonds. In Japan, investors are concerned about where the dollar might go and how their investments will fare given the changing exchange rate. Right now, international governments, businesses, and investors are considering all of their options for the highest and best return, and U.S. bonds are losing some favor.

According to history, there are two clear paths to see interest rates turn down again:

These two forces suggest that mortgage rates could be in the 5% range within the next 12 to 24 months, which would be a powerful demand driver for the housing market. However, as we’ve seen so far in August, a number of factors may contrive to keep mortgage rates high.