Bank of America: Mortgage rates could hit 5% under these conditions

The
other factor putting downward pressure on mortgage rates—and long-term
yields—has been a recent stretch of softer-than-expected labor market
data and financial markets’ growing expectation that the Fed will shift
policy from restrictive to neutral.

Even though the Fed’s expected short-term rate
cuts haven’t happened yet (a 25-basis-points Fed cut is expected
tomorrow), analysts at Bank of America believe that most of the 2025
decline we’ll see in mortgage rates is already baked in. In fact, in a
forecast Bank of America published on Tuesday, they project that the
average 30-year fixed mortgage rate will likely end 2025 at 6.25%.

What would it take to get the average 30-year fixed mortgage rate to 5%?

“The
MBS team [at Bank of America] does see a path to a 5% mortgage rate if
the Fed does MBS quantitative easing and yield curve control, driving
the 10-year [Treasury yield] down to 3.00%-3.25%,” wrote Bank of America
analysts in a report published on Tuesday.

When Bank of America
says “MBS quantitative easing,” it means the Fed’s going out and buying
mortgage-backed securities—something it has done in recent decades when
the economy and labor market have weakened.

Long-term yields—such
as the 10-year Treasury yield and the average 30-year fixed mortgage
rate—are determined by demand (or lack of demand) for the underlying
bond. Yields move inversely to bond prices. If demand for long-term
bonds rises, bond prices go up and yields/mortgage rates fall. If bond
demand falls, bond prices drop and yields/mortgage rates rise.

Hypothetically,
if the unemployment rate were to spike and the economy weakened,
financial markets could respond with a flight to safety—driving up
demand for Treasuries, which would push bond prices higher and
yields/mortgage rates lower. At the same time, the Federal Reserve could
respond with emergency cuts to the federal funds rate and, if the
downturn were severe enough, potentially resume purchases of
mortgage-backed securities (MBS), adding further downward pressure on
mortgage rates.

Big
picture: If the average 30-year fixed mortgage rate falls to 5% anytime
soon, Bank of America believes it would likely be because the economy
has taken a negative turn, or perhaps because the central bank adopted a
new policy approach—and resumed buying mortgage-backed securities.