THIS is what has locked up the housing market: Economic strategist

Key Concepts

• AI Capex: Capital expenditure focused on Artificial Intelligence infrastructure and development, considered a key driver of the current stock market rally.
• Reverse Repo Market: A facility used by the Federal Reserve to temporarily drain liquidity from the banking system.
• Bifurcated Economy: An economic structure characterized by a significant wealth gap, with the upper 40% owning assets and the lower 60% largely lacking them.
• Rstar (Neutral Rate): The theoretical interest rate that neither stimulates nor restricts economic growth.
• Bond Vigilantes: Investors who sell bonds in response to perceived excessive government borrowing or inflationary policies, driving up interest rates.
• Yield Curve Steepening: A situation where the difference between long-term and short-term interest rates increases.
• Portable Mortgages: A proposed mortgage product allowing borrowers to transfer their mortgage rate to a new property.
• Private Credit: Lending provided by non-bank financial institutions, often with less stringent underwriting standards than traditional banks.

The 2025 Market Rally, the Fed, and Housing Affordability

The stock market’s 2025 rally is primarily fueled by optimism surrounding big tech and, crucially, capital expenditure (capex) in Artificial Intelligence (AI). Economist Francis Newton argues this rally is contingent on two key factors: AI capex and the actions of the Federal Reserve.

The Fed’s Liquidity Management and its Impact

Newton highlights a significant development: the Fed borrowed approximately $75 billion from the reverse repo market by the end of 2025. This action, he explains, maintains high liquidity, which in turn supports investments in AI and other areas, primarily benefiting the upper echelon of the economy. He contends that the Fed’s reluctance to lower interest rates disproportionately burdens the lower end of the economic spectrum, exacerbating existing inequalities.

“By not lowering rates and continuing to lower rates, you're putting the onus on the lower end of the economy. And we live in a bifurcated economy where the upper 40% own assets, the lower 60% don't. So it would be better to lower rates.” – Francis Newton

He anticipates pressure from Donald Trump to lower rates to address affordability concerns, particularly regarding pricing. Despite a cautious tone in recent Fed minutes, a rate cut is anticipated potentially in March or April, with market pricing suggesting one to two cuts throughout the year.

Interest Rate Dynamics and the 10-Year Yield

A key challenge remains the Fed’s inability to reach its 2% inflation target, which is keeping the 10-year Treasury yield above 4%. Newton clarifies that while the Fed sets the Fed funds range and discount rate, it doesn’t directly control the Fed funds rate, leaving room for influence from “bond vigilantes.”

The yield curve has been steepening, with short-term debt rates decreasing (the two-year Treasury dropping 70 basis points) while long-term rates, like the 30-year mortgage, have increased (up six basis points). This dynamic is directly linked to affordability issues. Newton emphasizes the importance of the 10-year yield falling below 4%, stating, “It will… you know, get the champagne out, but otherwise it Yeah, it's about the tenure with with the mortgage story.”

He points out that even after three rate cuts, the 10-year yield remains higher than it was when the cuts began, because the market is comfortable with inflation above 2% while the Fed is not. This discrepancy is tied to the concept of Rstar, the neutral interest rate.

Housing Market Challenges and Potential Solutions

The housing market is primarily constrained by a supply issue, as homeowners are hesitant to sell and relinquish their low 3% mortgages for current rates of 6-7%. Newton believes the market is recalibrating, but affordability remains a significant hurdle, favoring the wealthy and private equity firms.

Trump’s proposed solutions include portable mortgages, 50-year mortgages, deregulation, and increased supply. Newton is particularly enthusiastic about portable mortgages, despite potential resistance from underwriters.

“You can take that 2.5% mortgage rate out of my dead cold hand. I will tell you that.” – Francis Newton

He acknowledges that private credit is increasingly filling the void left by conservative bank underwriting standards, and notes that spreads are historically tight, potentially indicating complacency.

Logical Connections and Synthesis

The discussion establishes a clear connection between the Fed’s monetary policy, interest rate dynamics, and the housing market. The Fed’s actions regarding liquidity and interest rates directly impact the 10-year yield, which in turn influences mortgage rates and housing affordability. The proposed solutions to the housing crisis, such as portable mortgages, aim to address this affordability issue. The AI capex driven rally is dependent on continued liquidity, which is influenced by the Fed’s decisions.

Ultimately, the analysis suggests that the 2025 market rally is built on a complex interplay of factors, with the Fed’s actions and the 10-year yield being critical determinants of future performance. Addressing housing affordability through innovative solutions like portable mortgages and increasing supply is crucial for broader economic stability. The rise of private credit as a lending alternative is also a noteworthy trend.