Mortgage rates fell to 6.64% on Tuesday as the U.S. imposed broad-based tariffs against Canada, Mexico and China.
The new tariffs kicked off a trade war with the three countries, and stoked fears the U.S. economy could be heading for a recession.
Mortgage rates dropped 10 basis points on Tuesday to their lowest level since mid-October. Rates are being hit by three different forces: 1) Investors fleeing equities for the safety of bonds, 2) higher recession odds, and 3) higher inflation expectations.
We are seeing the effects of 1) and 2) pushing rates lower, but—so far—not as much impact from 3), which would push rates higher. This is largely because investors believe it is unlikely the tariffs on America’s neighbors will be imposed for a long enough period to significantly impact the economy. This is highlighted by the fact that bond and currency markets aren’t moving all that much, even as equity markets fall.
While the new tariffs on Canada and Mexico are focused on a specific goal to stop drugs being smuggled into the U.S., it’s important to note that investors feel the real, ongoing trade war is with China. The administration is quietly increasing tariffs on China and on certain goods like steel and aluminum, as expected. These impacts were already priced into the market.
Economy heading in a stagflationary direction
While the latest economic data suggests weaker economic growth, we are still far from a recession. Starting last Friday, the Atlanta Fed’s GDPNow tracker started showing negative GDP estimates for Q1. It is currently at -2.8%. We should not take this seriously. That model is mistakenly extrapolating companies’ front-running imports as implying a severe recession.
Economic growth in Q1 is likely to be lower than expected, but still positive. A more realistic estimate is that the tariffs on Mexico and China would shave around 0.5 percentage points off of GDP growth. For context, Q4 GDP growth was 2.3%.
The economy is already headed in a stagflationary direction, however, with weaker—though not recessionary—economic growth and stickier (though not as high as the 2022 peak) inflation. This is why rates have been falling the last few weeks.
All of President Trump’s major initiatives—the immigration crackdown, reducing the size of the federal workforce, and increasing tariffs—are likely to decrease economic growth and make inflation stickier. In addition, the policy uncertainty itself is a drag on the economy.
Lower mortgage rates could help unlock home sales
For the housing market, the impact of the current economic cycle is not clear. Lower mortgage rates will help unlock home sales, which have been at rock bottom.
That positive effect could be partially offset, however, by a weaker job market—depending on the size and shape of the economic slowdown.
One-to-two Fed rate cuts are expected later in the year. Soft economic data could certainly move that timeline up, but the Fed will continue to be wary of cutting too soon given the inflation risks.
If the Mexico/Canada tariffs do stick for longer, then core inflation is expected to increase from the current 2.8% to something between 3-3.5%. The Fed would likely be very reluctant to cut in such an environment.
But it’s also possible the tariffs hit economic growth and the labor market before they hit inflation, in which case the Fed could end up cutting sooner and hiking later.
Another impact of ongoing tariffs would be higher construction costs. A substantial portion of U.S. building materials are imported from Canada. The tariffs are expected to raise the cost of these materials, leading to higher expenses for home construction and renovations.
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