Next target 8%? US mortgage rates soar to a three-year high as “higher for longer” trades sweep the real estate market

Zhitong Finance APP has learned that US mortgage rates are experiencing a sharp upward surge. In just over a month, the average rate for 30-year fixed mortgages has jumped a full percentage point, reaching a three-year high above 7.5%. As a result, homebuyer demand has contracted rapidly, and existing home sales data for September are expected to show a significant decline.

The immediate driver of this round of rate spikes is the general rise in global bond yields. Mortgage rates are particularly sensitive to changes in the 10-year US Treasury yield, which in recent weeks has surged to multi-year highs. Last week, the 10-year Treasury yield briefly surpassed 5.360%, well above the 3.97% level before the outbreak of the Iran conflict, and the 30-year yield also climbed to the highest level since 2002.

However, the forces that have driven bond yields so high in such a short period are far more complex than they appear. Economists are focusing on a group of interwoven factors—geopolitical shocks, resilient economic fundamentals, structural competition for capital, and fiscal debt dynamics—all of which have combined to force investors to completely rewrite their expectations for inflation and economic growth.

Daryl Fairweather, Chief Economist at Redfin, commented, "The trend is very clear. We are entering an environment with higher and more persistent rates, and there are fundamental changes behind this."

Geopolitical Shocks: The Iran Conflict and Energy Price Transmission

The upward trajectory of mortgage rates closely coincides with the outbreak of the Iran conflict. Within weeks of the US launching military strikes against Iran on February 28 this year, mortgage rates soared, as investors grew increasingly anxious about higher oil prices and their inflation implications. Concerns persist over rising energy prices being passed through supply chains, worsening inflation.

More critically, the uncertainty of the Iran situation itself remains a persistent source of upward pressure on rates. Jake Krimmel, Senior Economist at Realtor.com, noted: "Geopolitical uncertainty is a key component. We're talking about supply shocks—not only in oil, but potentially in all other areas of trade." Investors are demanding higher compensation for unknown risks, which directly manifests as an increase in term premiums.

According to PIMCO analysis, since the Iran conflict began, the energy market has consistently been the clearest source of uncertainty for risk assets. Six-month WTI crude futures have risen about 25% since the end of February, trending similarly to previous geopolitical oil shocks. The International Energy Agency projects that due to stalled US-Iran negotiations and disrupted oil supply recovery, global oil supply will fall by 5.7 million barrels per day to 100.7 million barrels by 2026. Full restoration of Gulf region oil supply is not expected until 2027.

US Treasury Secretary Scott Besant has tried to lower bond yields via Treasury buybacks, but with little effect. He attributes most of the rise in bond and mortgage rates to energy prices, stating: "I don't know if this conflict will end next week, next month, or in two months, but I believe on the other side of all this, energy prices will drop sharply, and rates and mortgage rates will also fall." However, most economists believe that energy prices alone cannot fully explain the current high-rate environment.

Economic Resilience: Strong Growth Provides Fundamental Support for Higher Rates

The US economy continues to demonstrate unexpected resilience, which underpins persistently high mortgage rates. Q2 GDP grew at an annualized 2.2%, consumer spending remains robust, and recent manufacturing and consumer spending indicators continue to show healthy growth.

"Consumers are still spending—indeed, spending more in real terms—which typically points to a strong economy," said Orphe Divounguy, founder and Chief Economist of Quantitative Research Group. He added, "With a strong economy pushing inflation well above the Fed's 2% target, investors are demanding additional compensation for holding long-term bonds," propelling yields and mortgage rates higher.

It is worth noting that the Fed's latest forecast shows that headline Personal Consumption Expenditure (PCE) inflation will reach 3.7% by the end of 2026, and the median for core PCE inflation has been sharply revised up to 3.4%. Persistently above-target inflation has made bond investors increasingly price in inflation risk.

This "good news is bad news" paradox is especially apparent in the mortgage market. Strong economic data means the Fed lacks urgency to cut rates, while above-target inflation requires a persistently restrictive monetary policy stance—both of which put upward pressure on bond yields.

AI Capital Boom: The “Crowding Out Effect” of the Tech Revolution in the Bond Market

Though it may seem unrelated, the financing wave for artificial intelligence (AI) infrastructure buildout is indeed a seemingly distant but profound driver behind rising mortgage rates. Large tech firms are pouring into bond markets at unprecedented scale to fund AI infrastructure such as data centers, chips, and servers.

Statistics show that tech industry borrowing has reached nearly $500 billion in the nine months since January this year, whereas the 2024 figure was close to zero. Goldman Sachs expects this to rise further to $1.2 trillion by 2027. James Vlachos, Acquisition Executive Director at fundraising advisory firm Post Oak Group, estimates that AI now accounts for 25% of all corporate bond issuances, up from only 4% two years ago.

On an inflation-adjusted basis, this year's borrowing by the AI industry is set to surpass the cable operators’ borrowing during the US internet buildout or even the 19th-century railroad boom. Investors are flocking to the bonds of these tech giants but are now demanding much higher yields than before. Even Meta (META.US) has had to offer over 7% annual yields, while higher-risk cloud data center specialists are exceeding 9%.

For bond investors, these deals are attractive: They offer yields higher than government bonds and are often issued by firms with credit ratings close to—or, in Microsoft's (MSFT.US) case, better than—the US government. Because bond yields move inversely with prices, when investors allocate more capital to AI debt and away from Treasuries and mortgage-backed securities, yields and mortgage rates rise.

This trend’s impact on the Treasury market merits close scrutiny. Mark Shernan, Chief Investment Officer for Non-Traditional Strategies at PIMCO, noted that AI-related bond issuance is "too much, too fast," potentially causing an "indigestion" in the fixed income markets. PIMCO CIO Dan Ivascyn has also stated that the AI corporate debt boom is a key factor pushing the 10-year US Treasury yield higher.

Karla Wu, Senior Economist at Zillow, noted, "The AI spending boom may have had a crowding-out effect on other similar investment vehicles." Whatever the degree of this effect, the massive supply of AI debt is altering the supply-demand balance of the fixed income market, and its upward push on the rate center cannot be ignored.

Fiscal Debt Spiral: Market Impact of the $40 Trillion Milestone

If AI debt represents a new type of capital competition, the US government's own debt expansion is an even more fundamental driver of higher rates. Treasuries have long been seen as the world's safe-haven asset, with market depth, liquidity, and the strength and stability of the US financial system attracting strong international investment demand, which has helped suppress yields.

However, this pattern is undergoing subtle but profound changes. Since the pandemic, US national debt has ballooned, surpassing a record $40 trillion earlier this year. Some new spending is tied to emergency pandemic measures that are being unwound, but the US frequently spends more than it takes in on social programs and defense. The FY2026 budget deficit has risen to $1.993 trillion, up 12% year-on-year, the highest since 2021 and expected to exceed 6% of GDP. Net interest spending has surpassed $1 trillion for the first time, and the average rate on marketable debt rose to 3.48%, more than two percentage points above five years ago.

This creates a self-reinforcing negative cycle: As yields rise, the government must devote a larger share of fiscal resources to pay ballooning interest on debt; the growing interest burden further amplifies concerns about US fiscal sustainability, prompting investors to demand higher risk premiums and thus pushing yields even higher.

The term premium on 10-year Treasuries has risen to about 0.98%, a 12-year high. Analysts note that the 30-year Treasury yield's surge above 5.3% is not merely a liquidity premium but reflects market risk pricing over US fiscal trajectory uncertainty. Treasury Secretary Besant has tried to stabilize the market via buyback operations, but, against a backdrop of $40 trillion in debt, buybacks alone struggle to counter market forces.

More worryingly, the full budgetary impact of the recent spike in yields has yet to manifest. Since rate changes affect only new issuance, refinancing maturing old debt takes time, meaning interest pressure will continue increasing over the next few years.

Fed Policy Path: Rate Hike Expectations Continue to Rise

Although the Federal Reserve does not directly control mortgage rates, its adjustments to the short-term federal funds rate deeply influence rate trends. Market expectations of the Fed's policy path are already largely reflected in current mortgage rates.

At its September FOMC meeting, the Fed raised its benchmark rate by 25 basis points to a 3.75%-4.00% range—the first hike since July 2023, with all 12 voting members in favor. Minutes show most participants expect another hike this year, but opinions vary on timing—some favor holding in October, leaving the next hike for December.

According to the CME FedWatch tool, investors currently price the probability of a 25 basis-point hike at the October 27-28 meeting at less than 20%, a sharp drop from around 70% in the days after the September decision, but the market has nearly fully priced in at least a 25 basis-point increase by year-end. Fed Governor Waller has also said that further hikes are needed, but not necessarily consecutively.

Is 8% Within Reach? The Housing Market's Tipping Point

With the combined effect of the above forces, the possibility of mortgage rates reaching 8% is shifting from "distant" to "increasingly likely." Quantitative Research Group's Divounguy stated bluntly, "It's no longer something far away—it's getting closer to reality."

HousingWire Chief Analyst Logan Mohtashami's rate scenario framework shows that an 8% mortgage rate would require the 10-year Treasury yield to rise to around 5.40%, along with a further deterioration in the mortgage spread. This also needs strong economic data, a hawkish Fed, and a continuation of the Iran conflict. However, the below-expected September non-farm payroll report meant the 5.40% 10-year yield did not trigger 8% mortgage rates, suggesting the spread has not yet deteriorated sufficiently.

Moody's Analytics Chief Economist Mark Zandi issued an even sterner warning: "There is no upper limit, there is no such thing as a cap." He said there is no reason why the bond market selloff wouldn't continue, and rates could approach 8% or even higher. Cotality Chief Economist Selma Hepp said in an extreme scenario, if the 10-year Treasury yield rose to 6-7%, combined with the current two-percentage-point mortgage spread, homebuyers would face mortgage rates of 8% or even 9%.

PIMCO's Ivascyn analyzed from a technical perspective: technical selling pressure such as leveraged funds’ stop-loss selling may push the 10-year Treasury yield above 6%—a level not seen in 26 years. He made clear that much of the recent market activity is directly related to "negative technical factors" and "stop-loss operations by platform hedge funds and other leveraged investors."

The housing market has already responded. According to the Mortgage Bankers Association, as of the week ending October 2, mortgage applications dropped 4.2% from the previous week, marking five consecutive weekly declines.

As for the rate outlook, Redfin expects mortgage rates to remain high and unlikely to decline significantly unless economic fundamentals change substantially. HousingWire’s scenario analysis finds that a 7% rate scenario would require the Iran conflict to end and no further trade friction—neither of which currently has a clear timetable for resolution.