Chief Economist Eugenio J. Alemán discusses current economic conditions.
The ability of the US economy to avoid a recession in 2022-2023, as the Federal Reserve (Fed) increased interest rates, rested, in part, on the resilience of non-residential investment, which was propped up by a strong private investment push from companies taking advantage of provisions in both the CHIPS Act as well as the IRA. But the effects from those two acts are starting to fade, which means that the non- residential investment buffer will not be there if the decline in residential investment is large.1
As the graph below shows, today, both residential and nonresidential construction spending are declining. This means that the risks of recession are still high today because the buffer that existed back in 2022-2023 is no longer there.
Recent data on builder sentiment, housing starts, and home sales, but especially on new home sales, all point to a housing market that is weakening again. This is likely the reason the Trump administration is putting so much pressure on the Fed to lower interest rates. However, as we have seen since the Fed started lowering interest rates last year, its effects on mortgage rates have been relatively muted, as the yield on the 10-year Treasury has remained almost unchanged as markets continue to expect higher inflation in the future. Thus, even if the Fed lowered interest rates, there are no guarantees that the yield on the 10-year Treasury and, thus, mortgage rates, will come down any time soon.
Furthermore, a critical factor in today’s housing market is the so-called ‘lock-in effect.’ As of Q12025, 81% of outstanding mortgage debt is locked in below 6%, with over 53% of homeowners holding mortgages below 4%. Only 18.8% of borrowers have rates above 6%. Furthermore, the average mortgage interest rate is 4.3%.2
This creates a powerful disincentive for households to relocate and be willing to sell their homes. For most homeowners, trading a 3% mortgage for a 6.5% one simply doesn’t make financial sense. Even if mortgage rates fall modestly, it may not be enough to unlock a larger inventory of homes. Given the current outstanding mortgage debt environment, rates will likely need to fall below 5%, and possibly closer to 4.5%, before a meaningful number of homeowners will consider selling.
The Fed began cutting rates in late 2024, and we expect further easing in the second half of 2025. But as we argued above (see graph), history shows that mortgage rates don’t increase or fall in lockstep with the Fed funds rate. In the 2001 and 2019 cutting cycles, mortgage rates declined gradually and modestly. During the 2007–2008 crisis, rates didn’t fall significantly until the Fed began buying mortgage-backed securities, as it implemented what was called Quantitative Easing.
Mortgage rates are more closely tied to the 10-year Treasury yield, and the spread between Treasuries and mortgage rates has widened due to market volatility and risk aversion. Even if the Fed cuts rates by 100 basis points over the next 12 months, mortgage rates may only decline incrementally.
The housing market is waiting for a catalyst, and that catalyst is lower mortgage rates. But the path to lower rates is highly uncertain and likely to be slow, unless the US economy goes into a recession. Until then, the market will remain constrained by tight inventory, high prices, and cautious builders.
If the Fed continues easing into 2026 and inflation remains under control, we could see mortgage rates fall below 5%. However, today, the Fed, as well as markets, are focused on the inflationary effects of tariffs, which is going to delay any meaningful reduction in mortgage rates. If mortgage rates fall below 5%, that is when we expect the lock-in effect to begin to ease. At that time, the inventory of homes could rise considerably, home prices would start to fall, and affordability would probably improve. Until then, the housing market will remain a drag on economic growth, one that could push the US economy closer to a recession.
1: We thank Tavis McCourt for pointing out that “non-residential construction put in place,” which skyrocketed in 2022, has started to weaken.
2: National Mortgage Database
Economic and market conditions are subject to change.
Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.
Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.
The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.
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