The Warsh Effect on Mortgages

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

**James Egan** (0:06)
And I'm Jim Egan, the other Co-Head of Securitized Products Research at Morgan Stanley.

**Jay Bacow** (0:10)
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.

**James Egan** (0:25)
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, but one of the key talking points we have now is we have a new Fed chair. We had the first FOMC meeting in his press conference after that last Wednesday.
What do you think that means for mortgage markets, for volatility? How are you thinking about this?

**Jay Bacow** (1:11)
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.

**James Egan** (2:03)
All right. 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?

**Jay Bacow** (2:22)
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 is that 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%.
Some of that is because with mortgage rates of 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?

**James Egan** (3:13)
Right, so the main thing that we focus on from a housing market perspective is less specifically Fed action and more the five and ten year part of the curve. So when you start to say something like you're tactically negative, mortgage backed securities here, how can I interpret that from a mortgage rate perspective?

**Jay Bacow** (3:30)
If we're tactically negative, it's more of a small move than some massive move. 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 more around the belly of the treasury curve. 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.

**James Egan** (4:00)
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 only 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. From the fourth quarter of 2023 through now, we've been roughly at the same level. That's 11 consecutive quarters now.