Podcast Summary: Thoughts on the Market

Episode: Can Fed Cuts Bring Mortgage Rates Down?
Date: September 15, 2025
Hosts: Jim Egan & Jay Bacow (Co-Heads of Securitized Products Research, Morgan Stanley)

Episode Overview

This episode explores the current challenges with mortgage affordability in the U.S. housing market, the anticipated Federal Reserve rate cuts, and whether these cuts are likely to bring down mortgage rates. Jim Egan and Jay Bacow examine the persistent “lock-in” effect that is keeping supply tight, break down the relationship between Fed policy and mortgage rates, and discuss what’s really needed to potentially spur housing activity.

Key Discussion Points & Insights

1. Affordability Crisis and the Lock-In Effect

• Current State: Homeowners with existing low mortgage rates (average below 4.25%) are disincentivized to move given new mortgage rates are over 6.25%, keeping supply off the market ([00:48]).
  • "The effective rate on the outstanding mortgage market, kind of the average of the mortgages outstanding, is below 4.25%. The prevailing rate for 30 year mortgages today is still over 6.25%" – Jim Egan ([00:48])
• Historical Perspective: This situation is highly unprecedented; never before in the past 40 years has the "out-of-the-money" spread (between current and prevailing mortgage rates) been this large for so long—over 200 basis points for three consecutive years ([01:23]).
  • "We have now been more than 200 basis points out of the money for three entire years, 12 consecutive quarters. So this is very unprecedented in the past several decades." – Jim Egan ([01:27])

2. Will Fed Cuts Lower Mortgage Rates?

• Key Takeaway: Cuts in the Federal Funds Rate are not directly bringing down mortgage rates.
  • "The Fed has already cut rates 100 basis points over the past year. And since the Fed has cut rates 100 basis points in the past year, the mortgage rate is 25 basis points higher." – Jay Bacow ([01:59])
• Yield Curve Relevance: Mortgage rates are significantly more sensitive to the mid-range (5- and 10-year) Treasury yields rather than the Fed Funds Rate ([02:39]).
  • "Mortgage rates are much more sensitive to the belly of the treasury curve, called the five and ten year portions, than Fed funds." – Jay Bacow ([02:39])
  • Jay (“nerding out") explains how the spread between 5- and 10-year notes implies that if 5-year yields rise in the future, mortgage rates could remain elevated ([02:39]–[03:39]).

3. Other Factors Keeping Mortgage Rates High

• Risk Premium: In addition to Treasury yields, there is a spread (risk premium) over Treasuries which can be influenced by factors like investor demand and capital requirements for holding mortgages ([03:46]).
  • "Mortgage rates aren't just predicated on where the treasury yields are. There's also a risk premium. ... If the capital requirements for investors to own those mortgages go down, that would certainly be helpful." – Jay Bacow ([03:46])
• Structural Limitations: Many fees and requirements are "stuck in place," limiting the impact of any changes ([03:46]).

4. What Would It Take to Boost Housing Activity?

• Affordability Ratio: Historically, a 10% improvement in the affordability ratio is needed for sustainable growth in housing sales ([05:24]).
  • "A sustainable increase. Historically we've needed about a 10% improvement in the affordability ratio." – Jim Egan ([05:24])
• Translation to Mortgage Rates: Dropping mortgage rates by about 100 basis points (from 6.25% to 5.5%) could, theoretically, provide this 10% improvement ([05:49]).
  • “We think you need about 100 basis point move. It would take the 30 year mortgage rate to call it 5 and a half percent.” – Jim Egan ([05:49])
• Timing of Impact: The boost in housing sales isn't immediate; growth tends to pick up about a year after affordability improves ([06:01]).
  • "A year after you start to see that real improvement, the contemporaneous moves can be up. They can be down... we do think you can see a little bit of contemporaneous growth if you start to see that 100 basis point move in mortgage rates." – Jim Egan ([06:01])
• Forecast: With such a drop in rates, the hosts expect a 5% increase in home purchase volumes through 2026, with a possible upward inflection in 2027 ([06:38]).

Notable Quotes & Memorable Moments

• Historical Context:
  "If we look at roughly 40 years of data ending in 2022, the market was only 100 basis points out of the money for eight individual quarters. The most it was ever out of the money was 135 basis points. We have now been more than 200 basis points out of the money for three entire years, 12 consecutive quarters." – Jim Egan ([01:27])
• Humor & Analogy:
  "I thought the Patriots were going to beat the Giants in both Super Bowls. Somehow Eli Manning proved me wrong." – Jay Bacow ([04:10])
• Realistic Conclusions:
  "It doesn't necessarily have to bring the mortgage rate down, but if the mortgage rate does go down to, in the context of five and a half percent, we should start to get a pickup in housing activity. Maybe. Maybe the year after that." – Jay Bacow ([06:38])

Key Timestamps for Reference

• [00:48] – Explanation of lock-in effect and spread between average and current mortgage rates
• [01:23, 01:27] – Historical comparison of out-of-the-money mortgage rate periods
• [01:59] – Assessment of past Fed cuts and their effect (or lack thereof) on mortgage rates
• [02:39] – Discussion of mortgage rates' sensitivity to the yield curve
• [03:46] – Breakdown of risk premiums and structural hurdles for lower mortgage rates
• [05:21–05:49] – What type of mortgage rate move could improve affordability
• [06:01–06:38] – How soon and how much could home sales rise after an improvement in mortgage rates

Summary Table

| Segment | Discussion Focus | Timestamp | |-----------------------------------|--------------------------------------------------------------------|------------| | Affordability & Lock-In | Average vs. current mortgage rates; unprecedented spread | 00:48–01:27| | Fed Cuts & Mortgage Rates | Why mortgage rates may not drop, yield curve relevance | 01:59–03:39| | Other Factors (Risk Premium etc.) | What else could lower rates, but structural factors limit impact | 03:46 | | Needed Rate Drop | 10% affordability improvement = ~100 bps rate cut | 05:21–05:49| | Expected Housing Activity Pickup | 5% growth in purchase volumes if rates drop to 5.5% | 06:01–06:38|

Takeaway

Federal Reserve interest rate cuts are not enough to ensure lower mortgage rates. Market pricing, the Treasury yield curve, and risk premiums play major roles. Even if mortgage rates eventually fall, significant improvement in affordability—and therefore in housing activity—will likely happen slowly and require more than just Fed action. A drop to roughly 5.5% on 30-year mortgages would be necessary for meaningful change, with tangible results in home sales possibly lagging by a year or more.