February mortgage rates forecast

I predict that mortgage rates will edge upward in February as the Federal Reserve moves toward restoring bond markets to normal.

The Fed has been intervening in bond markets to push down on interest rates and keep money flowing through the financial system during the pandemic. As that intervention draws to a close, mortgage rates will rise faster than the yields on the 10-year Treasury note, which is the vehicle that the government uses to get a 10-year loan. Usually, 30-year mortgages and 10-year Treasurys rise and fall roughly in tandem. But they got out of sync during the pandemic.

To get nerdy on you, I track the difference between the 30-year mortgage rate and the 10-year Treasury. It's my early warning system. When that difference gets out of whack, it can signify that mortgage rates are about to move. And it's been out of whack.

In 2019, pre-COVID times, the average 30-year mortgage rate was 2.04 percentage points higher than the 10-year Treasury yield. At the beginning of 2022, the difference was 1.58 percentage points. This is a sign that mortgage rates have room to move higher, even if Treasury yields stay about the same.

When you're at a Super Bowl party, the halftime conversation inevitably will turn to the local real estate market. If you want to impress people, refer to the differences between mortgage rates and Treasury yields as "spreads." You'll sound like a talking head on CNBC.

What happened in January

Mortgage rates rose at the end of December and kept going up most of the month. By Jan. 17, the 30-year mortgage had risen more than half a percentage point in four weeks. It's rare for mortgage rates to climb that swiftly.

The Federal Reserve was responsible for the increase in mortgage rates. The sequence of events started in 2020 as the central bank began buying billions of dollars worth of mortgage-backed securities and Treasurys each month. The purchases kept mortgage rates and other interest rates low.

The buying spree was part of the Fed's emergency response to the pandemic. The purchases must stop when the emergency is over — and the Fed dropped two hints in late 2021 that its pace would shift in 2022:

1. In November, the Fed announced that it would reduce those monthly purchases. Think of it as taking a foot off the accelerator and gently pressing the brake pedal. The Fed put itself on track to end its bond purchases in June 2022.

2. Then, in the middle of December, the Fed said it was done being gentle and that it would stomp on the brake "in light of inflation developments." So the scheduled end of bond purchases was moved up three months to March 2022.

It dawned on investors that the Fed was dead serious about using multiple tools to fight inflation; by reducing purchases of mortgage-backed securities and Treasury debt, raising a key short-term interest rate (probably in March) and reducing its vast holdings of mortgage debt.

Any of these three policy tools would be enough to push mortgage rates higher. In January, as it became clear that the Fed planned to wield all three tools this year, mortgage rates went up. That's because mortgage markets don't wait for the Fed to take action; interest rates go up and down based on what the Fed is expected to do.

Missing January's prediction

At the beginning of January, I predicted that mortgage rates would stay about the same and were more likely to fall than to rise. I said the economic effect of the omicron wave would keep rates from rising. I added that if I were wrong, it would be because "mortgage rates' recent upward trend is relentless" despite omicron and consumers' tendency to pay down credit cards rather than shop in January.

I was all kinds of wrong. Rates decisively went up. I didn't foresee the Fed's determination to set the course of interest rates higher to fight inflation.