Why housing won't get much cheaper when the Fed cuts interest rates

• America's housing market likely won't get more affordable anytime soon, Morgan Stanley said.
• Mortgage rates are poised to stay high even after the Fed eases monetary policy.

Homebuyers and renters shouldn't count on getting much relief from high housing costs, according to Morgan Stanley.

Costs have been steadily rising for both buyers and renters in the past year. The median US home price rose 5% year-over-year in May to a record $438,601, according to Redfin data. Meanwhile, median asking rents in the US ticked 0.8% higher to $1,653 a month, just $47 shy of the all-time high notched in 2022.

The surge in home prices has been driven by the "lock-in" effect throughout the market, as prospective sellers hold off listing their homes to avoid having to finance a new mortgage at a higher rate than what they locked in previously.

Sidelined homebuyers, meanwhile, have been renting, which has driven demand for rental units and raised costs.

The result is the most unaffordable housing environment buyers and renters have seen in years. Renters now have to make 36% more than they did prior to the pandemic to afford the typical apartment, Zillow estimated, while buyers need to earn a whopping 80% more to comfortably afford a home.

"For the US, a key part of the housing story has been the mortgage lock-in for homeowners," Seth Carpenter, Morgan Stanley's global chief economist said in a recent podcast. "Our strategists have noted that the gap between the current new mortgage rate and the average effective mortgage rate is at historical highs. And the share of 30-year fixed-rate mortgages is at its highest in a decade."

Market-watchers have been eyeing Fed rate cuts as a lever that will possibly make housing more affordable. Lower borrowing costs could influence mortgage rates to fall, but the Fed is unlikely to lower rates enough to dent home prices, and therefore, rents, Carpenter said.

"There will be a decline in mortgage rates if we get the modest easing cycle from the Fed that we expect. But that decline will be similarly modest so that gap in rates will not be fully closed even if it narrows," he added. "And ultimately, what we think is going to happen is that there'll be a moderation in home price appreciation, but not an outright decline in home prices."

That's expected to keep the "arbitrage condition" between home prices and rents alive over the longer run, Carpenter said — another way to say housing costs are likely to remain elevated.

Other market forecasters have warned that the Fed looks poised to keep interest rates higher for longer, with the central bank spoiling hopes for ambitious cuts that markets had predicted earlier in the year. According to a growing chorus of Wall Street bears, central bankers may not cut interest rates this year at all due to the risk of resurgent inflation.

"The housing market might be telling us that monetary policy is working a bit less effectively than historically, but not that monetary policy is not working," Carpenter said. "We do not think the housing market overall is at risk of collapse, but the monetary policy is restraining activity in a very familiar way."

Markets expect the Fed to keep rates steady at its July policy meeting and to initiate the first cut in September. The 30-year fixed mortgage rate clocked in at 6.86%, according to Freddie Mac data.