US mortgage rates hit a three-year high, but the "downside stickiness" of housing prices increases the challenge for Federal Reserve policy

Zhitong Finance APP reports that U.S. mortgage rates have risen for the sixth consecutive week, reaching a near three-year high and pushing potential homebuyers to the sidelines. According to data released Wednesday by the Mortgage Bankers Association (MBA), the 30-year fixed-rate mortgage contract rate jumped 18 basis points to 7.30% for the week ending September 25, the highest since November 2023; the five-year adjustable-rate mortgage (ARM) rate surged 37 basis points to 6.47%, the highest in more than two years.

Rising financing costs mean more difficulties for an already struggling housing market. MBA's purchase index (which measures loan applications) fell 4.3%, the lowest since April 2025; the refinancing index dropped another 8.7%, extending its decline since mid-August. Joel Kan, MBA Vice President and Deputy Chief Economist, explained the chain plainly in the official press release: “Mortgage rates surged to their highest level in nearly three years, pushing borrowers to the sidelines.”

By component, mortgage applications fell 6% this round, with both purchase and refinance applications dropping to the slowest weekly pace since 2025; government-backed refinance applications fell 13%, FHA and VA applications saw double-digit declines; ARM accounted for 10.3% of total applications, the highest since October 2025—the roughly 80 basis point spread between ARM and fixed rates is attracting more to choose ARM products.

Housing Market: Supply is Back, But Prices Won't Fall

Mortgage rates and existing home sales have always moved in opposite directions, but this round of slowdown is uneven. According to the National Association of Realtors (NAR), existing home sales in August fell 2.0% month-on-month and 1.2% year-on-year, with a seasonally adjusted annual rate of 3.98 million units, the weakest since June 2025; inventory for sale rose to 1.62 million units, up 3.2% month-on-month and 5.9% year-on-year—the first time since November 2019 to exceed 1.6 million units, which at the current sales pace equals 4.9 months of supply, the highest in over a decade. NAR’s chief economist Lawrence Yun said that ample supply is giving buyers “better negotiating opportunities”: about 20% of homes for sale in August saw price drops, the percentage of homes sold above list price fell from 20% a year ago to 16%, and the median time a home spent on the market was 31 days.

But prices haven’t turned: the median price for existing homes in August was $429,100, up 1.6% year-on-year, marking the 38th consecutive month of increase; in deals below $2.5 million, transactions fell 10% year-on-year, while those above $1 million increased 3.9%, with the only growth in the highest price segment. Yun attributes this to wages and employment—wages grew 3.1% year-on-year in August, with 643,000 new non-farm jobs added in the year. “Job creation and wage growth typically drive housing demand.”

This is also the reason why Mark Fleming, Chief Economist at title insurance company First American Financial, judges housing prices as being “downside sticky.” He notes that with mortgage rates over 7%, more people are locked into their current homes—the gap between homeowners’ 3% or 4% mortgages and current rates is widening.

According to the FHFA national mortgage database for Q1 this year, about 66.7% of outstanding mortgages had rates below 5%, 49.9% below 4%, and 19.5% below 3%, with an average outstanding mortgage rate of around 4.5% (Morgan Stanley estimates about 70% below 5% and about half below 4%). Replacing with a home of comparable value would mean a significant jump in monthly payments, thus making “not selling” a rational choice. Fleming believes sales may slow further, but unless a major economic recession triggers forced sales such as foreclosures, a significant drop in prices is unlikely—prices “will generally slow their rise or stop rising.”

Inflation: Why Does Housing Still Prop Up Core CPI?

Shifting focus from the housing market to the price index reveals an oddity: with such a cold real estate market, why does housing inflation still prop up core CPI?

According to data released by the U.S. Bureau of Labor Statistics on September 11, August’s CPI rose 3.4% year-on-year (unchanged from last month), and up 0.4% from July; core CPI excluding food and energy rose 2.4% year-on-year, slightly below last month’s 2.5%. Meanwhile, the shelter component rose 3.0% year-on-year, down from 3.2% in July and continuing to decline; it was up 0.3% month-on-month, with the largest subcomponents—owner’s equivalent rent (OER) and rent of primary residence (RPR)—both up just 0.2%, with the monthly increase mainly driven by a 2.4% jump in lodging away from home (hotels).

The key is the weighting and calculation method. According to the National Association of Home Builders (NAHB), the shelter component makes up over 40% of core CPI; another common measure places it at roughly one-third of total CPI. OER measures what homeowners estimate their house could rent for, not the actual costs such as insurance, property taxes, or maintenance; meanwhile, rent data is collected via surveys and lags changes in market rents by 9 to 12 months before incrementally showing up in the index.

This means the current high mortgage rates and home prices are unlikely to cool inflation quickly via the shelter component; conversely, as long as the shelter component grows at a 3% pace, core CPI will struggle to quickly fall back to the 2% target—in August, the supercore index (core services excluding shelter) was still up 3.1% year-on-year, also confirming the stickiness of service prices.

The Other End of the Chain: 10-Year U.S. Treasury Bonds and the Federal Reserve

Mortgage rates aren’t set directly by the Fed—they’re anchored to long-term funding costs: 30-year mortgage rates mainly track the 10-year U.S. Treasury yield, plus a risk premium for prepayment on mortgage-backed securities (MBS), where major forecasting models currently assume a spread of about 2 percentage points.

And the 10-year US Treasury yield is trading at record highs. According to Treasury closing quotes, the 10-year ended Monday at 5.2361%, with an intraday high of 5.27%, its highest since June 2007; the more policy rate-sensitive 2-year note ended near 4.93%; and the 30-year yield reached 5.62% intraday on September 29, a new high since 2002. Drivers of higher yields and mortgage rates are the same: Middle East tensions pushing up energy prices, a rebound in inflation expectations, Treasury deficit and bond supply concerns pushing up term premia, and a more hawkish Fed outlook.

Earlier this month, the Federal Reserve raised rates for the first time since 2023, lifting its benchmark rate to 3.75% to 4.00%. According to the dot plot from the Fed’s policy meeting, 12 of 16 officials expect one more rate hike this year and four expect two; Fed Chair Kevin Warsh said post-meeting that the central bank’s preferred inflation measure, PCE, was running at about 3.6% in August. Investors generally expect one more rate hike before the end of the year.

Forecasting agencies have already cut their housing market outlook. According to the latest MBA forecast, 30-year fixed mortgage rates conforming to Fannie Mae and Freddie Mac standards will be around 6.8% in the fourth quarter, staying there through June next year, up from last month’s forecast of 6.7%; 2026 refinancing volume is estimated at $700 billion (below August’s $713 billion and July’s $747 billion forecasts), dropping further to $634 billion in 2027; existing home sales are expected to be about 4.105 million units.

Fannie Mae’s stance is similar: the average 30-year rate over the next three months will be 6.8%, dipping to 6.7% in Q1 next year. Both agencies expect the 10-year yield to end the year around 4.8%—which means the 6.8% mortgage rate forecast itself assumes a slight pullback in long-term yields and inflation expectations over the coming months; last week’s 7.30% is about 50 basis points above that assumption.

Where is the Cycle Stuck?

Put the four sections together and it is a self-reinforcing loop: high housing costs push up living and labor costs, propping up services inflation; services inflation and energy prices make it tough for the Fed to pivot, keeping long-term yields high; long-term yields determine mortgage rates, high mortgage rates freeze move-up demand, suppress transaction volumes, and intensify supply shortages; tight supply makes home prices “downside sticky,” with both prices and rents continuing to fuel shelter inflation. Hiking policy rates can suppress demand, but can’t move the most lagging link in the cycle—the reporting lag of shelter and the lock-in effect for homeowners.

There are signs the cycle might loosen: inventory has begun to recover (4.9 months’ supply is the highest in over a decade), more sellers are cutting prices, and the share of outstanding mortgages below 4% by FHFA measures has now slipped from its peak to 49.9%, meaning the lock-in effect will naturally ease as low-rate loans are gradually paid down; if long-term yields drop, the move-up chain will thaw first. But with the August CPI shelter component still at 3.0% and September CPI data not released until October 14, the only thing visible to the market now is the same trend: higher rates, colder sales, and prices not falling.