Mortgage rate forecast for Q4 2021: Inflation — and Fed’s response — will push rates up

Photo by Getty Images/Illustration by Orli Friedman/Bankrate

Mortgage rates plumbed new depths in December and January, setting all-time lows south of 3 percent. Rates have bounced around since then, topping 3.3 percent in March before dropping to 3 percent this summer.

Their trajectory for the rest of 2021 depends on a factor that hasn’t played a prominent role in the mortgage market for decades — inflation, and the Federal Reserve’s response to rising prices.

That’s according to Greg McBride, CFA, Bankrate chief financial analyst. With coronavirus vaccines widely available, optimism about the U.S. economy abounds. Yet so do fears about rising inflation. While the Fed insisted this summer that soaring prices were “transitory” and would fade away, that no longer seems an accurate reading.

“Inflation is running hot and even the Fed acknowledges what we all felt in the pocketbook, that it may last longer than they thought,” McBride says. “Mortgage rates could tick a bit higher in the fourth quarter if inflation remains stubbornly high and the Fed is slow to begin tapering asset purchases, despite continued economic strength.”

Housing economists say the growing optimism will push rates up, if slowly. The Mortgage Bankers Association, for instance, expects the average 30-year fixed rate to reach 3.1 percent by the end of 2021. Its forecast three months ago called for rates to hit 3.6 percent in late 2021. In other words, accurately predicting rates ain’t easy, especially in a global pandemic.

Fewer refis, more purchases

With rates trending upward, the refinancing boom of 2020 is slowing dramatically, says Michael Fratantoni, chief economist at the Mortgage Bankers Association. He expects refi volume in the fourth quarter of 2021 to plunge to barely a third of the levels seen in the fourth quarter of 2020.

While mortgage rates will rise enough to discourage refinancing, they’ll remain low enough to make homebuying attractive, Fratantoni says. He predicts record-breaking purchase mortgage volumes in 2021, and then again in 2022 and 2023.

We’re anticipating a very strong housing market,” he says.

How the Federal Reserve affects rates

The Federal Reserve doesn’t control mortgage rates, but the central bank does set the overall rate environment. The Fed slashed its federal funds rate when the coronavirus recession began in early 2020, and it had signaled that it would keep rates low for years, which would translate to little upward pressure on mortgage rates. However, that calculus has changed in recent months.

“The job market has improved, inflation is running hot and supply chain constraints are persisting,” Fratantoni says. “As a result, it is not surprising that the Fed will begin to remove accommodation.”

At its Sept. 22 meeting, the Fed sped up its timetable for rate hikes. Most Fed members now expect an interest rate hike in 2022 — “which is faster than many market participants had previously anticipated,” Fratantoni says.

While the federal funds rate doesn’t directly affect mortgage rates, there is a strong correlation between the rate on 10-year Treasury bonds and the 30-year mortgage. That spread widened in the spring and summer.

The typical gap between the 10-year government bond and the 30-year fixed-rate mortgage is 1.5 percentage points to 2 percentage points. During the scary early days of the COVID-19 pandemic, that spread rose as high as 2.7 percent. However, the gap has returned to normal.

Generally, an improving economy correlates to rising mortgage rates. Economists and investors think the U.S. economy will continue its uneven rebound. However, it’s unlikely that mortgage rates will soar, housing economists say.

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