Here’s how low mortgage rates have to go to restore the frozen U.S. housing market.

 

Nvidia’s results and guidance are out and continue to be parsed early Thursday. Save a few stragglers, it all but draws the curtain on the second-quarter earnings season.

This should allow for even greater focus on macroeconomic market catalysts, particularly the likely pace of Federal Reserve interest rate cuts.

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But that raises a crucial question for investors, according to U.K. fund manager M&G Investments: “If recent rate hikes haven’t significantly slowed the economy, how can we assume that traditional rate cuts will effectively stimulate it? And just how low must rates go to have an impact?”

In a new note, M&G fund manager Richard Woolnough and investment director Carlo Putti argue that the U.S. housing market, with its impact on consumer sentiment and wealth, and its importance as an economic multiplier, is a key channel for monetary policy transmission.

To put it simply, this monetary mechanism is not working as normal due to the unique nature of the current housing market. In particular, as the chart below shows, there is a bifurcation between the average time new and existing homes stay on the market.

Why is this? “On one side, existing homeowners, who have locked in historically low mortgage rates, have little incentive to move, since doing so would mean giving up those competitive rates. On the other side, new homebuyers are willing to buy but cannot afford to, as elevated mortgage rates have made housing largely unaffordable for them,” say the investors.

So, what level of interest rates are required to restore balance to the housing market and stimulate all the related activity?

For first-time buyers affordability is near historic lows. As the next chart shows, in order to restore market affordability — allowing for a median family to have just enough income to get a mortgage on a median-priced home — the line would need to return to the 100 level.

“To achieve this, we calculate that mortgage rates would need to drop to 3.4% (assuming all other factors remain constant),” say the team.

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That’s a long way off. According to Freddie Mac, the average 30-year fixed-rate mortgage was 6.46%.

For existing homeowners the situation is different. Affordability is mostly not an issue given their lower loan-to-value ratios. For them it is a matter of incentive, say the team, with most reluctant to move and give up their low mortgage rates.

“To incentivize most existing homeowners to move, rates would need to fall to levels similar to those they originally locked in. This would be around 3.5%, which is the average mortgage rate available during the period around COVID-19, when many either bought a house or refinanced their existing debt,” they say.

In conclusion, the pair say that because the transmission mechanism of interest rates has been dampened in the restrictive phase, and will likely also be less effective in an easing phase, then to effectively stimulate the economy via the housing market, mortgage rates may need to fall significantly.

“Our analysis indicates that to restore activity in the housing market, mortgage rates might need to drop to around 3.5%. Historically, this would correspond to a reduction in the 10-year U.S. Treasury yield, potentially towards 2%, depending on broader economic conditions and Federal Reserve policy,” they say.

The 10-year BX:TMUBMUSD10Ywas yielding 3.83% on Thursday morning. It looks like housing market sclerosis will stay around awhile.

Markets

U.S. stock-index futures ES00 YM00 NQ00 are higher as benchmark Treasury yields BX:TMUBMUSD10Y rise after stronger-than-expected GDP data. The dollar index DXY is up, while oil prices CL.1 rise and gold GC00 is trading around $2,510 an ounce.

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The buzz

Nvidia shares NVDA are down about 4% after delivering guidance that could not match heightened expectations.

CrowdStrike shares CRWD are down 1% despite an earnings beat by the cyber-security company, while Salesforce stock CRM is jumping nearly 6% after the software group boosted its margin outlook.

Dollar General stock DG is tumbling 25% after the discount retailer reported fiscal second-quarter profit and sales that missed expectationsand slashed its full-year outlook.

U.S. second-quarter GDP was revised higher from 2.8% to 3%while weekly initial jobless claims were 231,000roughly in line with forecasts.

U.S. pending home sales for July will be released at 10:00 a.m.

Atlanta Fed President Raphael Bostic will deliver a speech at 3:30 p.m.

Companies reporting earnings after the close include Dell Technologies DELL, lululemon athletica LULU and Ulta Beauty ULTA, the latter a new holding of Warren Buffett’s Berkshire Hathaway.

The Treasury will release results of a $44 billion auction of 7-year notes at 1:00 p.m.

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The chart

As noted above, the transmission mechanism of monetary policy is weaker than in the past, and despite the fed funds rate being at the highest level in decades, capex spending by the Magnificent Seven is at record-high levels, as this chart from Torsten Sløk, Apollo chief economist, shows.

“Fed hikes are having a much smaller negative impact than normal on business investment decisions because of the strong appetite among firms to invest in AI,” says Sløk.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

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