BLOG VIEW: The surprising fall in oil prices and interest rates in 2015 tells us that the global economy is still struggling to recover. That is likely to lead to continued low interest rates, which will keep housing affordable and support growth in home sales.
As we start a new year and close the books on 2015, I want to reflect on the year's biggest surprises and think about what they mean for 2016 and beyond.
Lower oil prices and lower interest rates come to the top of my mind. Beginning in late 2014, oil prices started to pull back sharply. That shock was widely attributed to rising U.S. shale oil production and OPEC's decision not to cut back its production quota. In other words, oil producers decided to continue pumping even as prices fell.
What has kept prices low this year, however, is that weaker global economic growth has dampened global demand for oil and other commodities – preventing a quick rebound. In particular, the economy of China, which has been the leading source of growth in energy consumption, has slowed dramatically, pulling down demand around the world and driving prices to their lowest level since the 2008-2009 financial crises.
Over the next few years, even if China's economic growth stabilizes, new growth drivers will likely be centered on its domestic services sector and will yield smaller gains for energy demand and energy prices. This has been the path other successful emerging market economies have followed.
Lower global economic growth is also the source of the second surprise this year – that interest rates have remained low. At the end of last year, the consensus was that interest rates on 30-year conventional mortgages would rise from 4.0% then to 4.9% by the end of 2015. Most economists were convinced that the Federal Reserve would raise the fed funds rate by the middle of 2015, pushing up interest rates on mortgages. Instead, what we saw was a wave of monetary easing as central banks responded to the slowdown in the global economy – ranging from quantitative easing in the Eurozone to interest rate cuts in China, Australia and Canada.
In September, even the Federal Reserve decided to delay a widely anticipated rate increase. Throughout the year, 30-year mortgage rates have fluctuated between 3.7% and 4.1% and averaged 3.8%, down from last year's 4.0%.
These surprises show that global economic conditions are increasingly important to what is happening in the U.S., and that economic developments outside of the U.S. will also affect borrowing costs and the cost of homeownership in the U.S.
What does this mean for the mortgage market?
Lower interest rates in 2015 spurred many borrowers to refinance, driving up refinancing volume 74% in the first three quarters of 2015 over the same period last year. Lower interest rates also supported housing affordability and had a positive impact on the housing market.
The important lesson here is that the pace of global economic growth after the financial crisis has entered a new era of slow growth. This era started with the financial crisis in the U.S., continued on with the crisis in the Eurozone, and is now spreading to China. The Eurozone and China are still finding their way through their adjustments, which will likely take years.
The U.S. is furthest along the road to recovery, with the labor market now close to full employment, but the pace of growth in income, at just 2.0%, has been slow by historical standards. The lack of growth is holding down interest rates and because we don't see the emergence of any growth impulse, we expect the 30-year mortgage rates to stay in the low-4.0% range as the most sustainable scenario from an affordability point of view.
This is different from the consensus, which forecasts interest rates on 30-year conventional mortgages will rise from 4.0% today to 4.4% in June 2016 and to 4.6% in December 2016. Slow income growth, coupled with moderate appreciation in home prices, means that potential home buyers will not have the ability to afford a sharp increase in mortgage rates. This is a lesson we learned in 2014, when a sharp uptick in mortgage rates caused a decrease in home sales and was eventually reversed.
Even if rates go up slightly next year, the pace of increase is likely to be slow and intermittent. It is very unlikely that rates will go up continuously quarter after quarter.
Although slow economic growth is bad news for the overall U.S. economy, the resulting low interest rate environment will benefit borrowers and home buyers by keeping homeownership highly affordable. Today, a typical family earns just under $68,000 a year. To buy a typical single-family home with a 20% down payment, which costs around $224,000, that family will have a monthly repayment of $860, representing just 15% of its monthly income, which is very low by historical standards. That monthly repayment is also cheaper than rent in 2016 and will not go up as rent will – which makes owning a very attractive option.
Tian Liu is the chief economist at Genworth Mortgage Insurance.
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