The math of the American dream just shifted. Yesterday, December 1, 2025, Morgan Stanley analysts Jay Bacow and James Egan released their definitive outlook for the 2026 housing cycle, and the numbers are a cold shower for those expecting a total market collapse. Instead of a crash, the data points toward a controlled descent into a new equilibrium. The headline number is 5.75 percent. That is where Morgan Stanley expects the 30-year fixed-rate mortgage to land by the end of next year, a significant drop from the 6.2 percent level we are seeing in the market today.
The Great Spread Compression
Mortgage rates are not just a reflection of the Federal Reserve. They are a reflection of risk. For the past two years, the spread between the 10-year Treasury yield and the 30-year mortgage rate has been historically bloated, often exceeding 250 basis points. As of this morning, with the 10-year Treasury hovering near 4.09 percent, that spread remains a heavy tax on homebuyers. But Bacow and Egan are calling for a structural shift.
Their thesis hinges on a bullish outlook for the mortgage asset class. They expect Government Sponsored Enterprises (GSEs) like Fannie Mae and Freddie Mac to expand their portfolios in 2026, absorbing nearly a third of net issuance. Combined with a projected return of domestic banks to the mortgage-backed securities (MBS) market, the technical environment is ripening for spread compression. If the spread returns to its long-term average of 170 to 180 basis points, the 30-year rate could fall even if the Fed remains relatively hawkish. This is the 125-basis-point opportunity that institutional investors are currently hunting.
Inventory as the Safety Valve
Supply is finally moving. Per the November 2025 existing home sales report, inventory levels rose 7.5 percent year-over-year. While this is still a far cry from the pre-pandemic norm, the trend is undeniable. The “lock-in effect,” which kept millions of homeowners tethered to their 3 percent mortgages, is beginning to fray at the edges. Life events—divorce, relocation, and growing families—are starting to outweigh the financial cost of a higher interest rate.
Egan points out that home price appreciation (HPA) has already cooled significantly. We started 2025 at 4 percent growth; we are ending it below 1.5 percent. Morgan Stanley is forecasting a modest 2 percent HPA for 2026. This is a “Goldilocks” scenario for the market: high enough to prevent a negative equity spiral, but low enough to allow wage growth to catch up to housing costs. The median sales price of existing homes currently sits at $409,200, according to data from the National Association of Realtors. If the 2 percent forecast holds, the entry-level buyer is still looking at a grueling climb, but the trajectory of the climb is flattening.
The Regional Disconnect
Not all zip codes are created equal in this recovery. The South and Northeast saw modest sales growth in November, rising 1.1 percent and 4.1 percent respectively. Meanwhile, the Midwest is flagging, with sales down 2 percent month-over-month. This regional fragmentation is driven by two factors: localized inventory replenishment and state-level tax policies. Investors are following the migration patterns. Institutional capital is pivotting away from the oversaturated Sun Belt metros and toward “Value Cities” where the affordability index hasn’t yet hit the floor.
The Bullish Case for Mortgage Assets
The real story isn’t just about the houses; it is about the debt. Bacow argues that the mortgage asset class is currently one of the most attractive risk-adjusted plays in the fixed-income world. The technical demand for Agency MBS is expected to surge as volatility dies down. High volatility is the enemy of mortgages because it increases the cost of hedging prepayment risk. As the Fed moves into a more predictable rhythm of 25-basis-point cuts, that volatility tax disappears.
For the retail trader, this means watching the 10-year Treasury yield like a hawk. Every 10-basis-point drop in the 10-year is currently being amplified into a 15-to-20-basis-point drop in primary mortgage rates due to that spread compression. This is the mechanism that will unlock the 4.13 million annualized sales pace we saw in November and push it toward the 4.5 million mark by mid-2026.
Housing remains the most interest-rate-sensitive sector of the U.S. economy. The narrative of a “frozen” market is accurate for today, but the 2026 outlook suggests a thaw is imminent. The risk-reward balance has shifted from “waiting for a crash” to “timing the entry.” As mortgage rates descend toward that 5.75 percent target, the margin of safety for buyers increases, but so does the competition for a still-limited pool of homes.
The next critical milestone occurs in the third week of January 2026. Markets will be looking for the first Case-Shiller report of the new year to see if the 1.5 percent price growth floor holds or if the inventory surge in the final weeks of 2025 has finally forced a month-over-month price contraction.
