The Federal Reserve just announced another rate cut. But will it matter to nervous homebuyers waiting for mortgage rates to fall?
On Thursday, at the end of its November meeting, the Fed announced a 0.25 percentage point cut to the federal funds rate, or the rate at which banks lend each other money overnight. The move follows an initial half-percent rate cut in September.
Both times, the consensus was that such interest rate cuts would – albeit indirectly – lead to lower mortgage rates. After all, mortgage rates have been falling steadily in recent months: between early July and mid-September, when the central bank announced the initial cut, they fell almost a full percentage point in anticipation of the move.
Since then, however, mortgage rates have moved in the opposite direction. In the six weeks since the Fed announced its first cut in mortgage rates, increased by 0.70 percentage points—not the result many expected. In theory, this new cut should help rates go down.
But if the first one didn’t work, will the second one help?
Probably not—at least not right away. In addition, the results of the presidential election may influence whether it even takes place.
The Fed’s influence on interest rates
The Federal Reserve’s monetary policy influences the financial choices of individuals and businesses, from purchases to hiring decisions. Typically, high interest rates make borrowing expensive and reduce inflation by reducing consumer demand; low interest rates do the opposite. But this influence can be direct or indirect.
The direct impact is on short-term rates typically charged on loans that mature in less than a year. Short-term rate products include certificates of deposit (CDs) and adjustable rate mortgages, the latter of which interest rates adjust every six months.
However, long-term rates are used for debt instruments with maturities ranging from one year to 30 years (or more), such as mortgages. Because these rates remain constant over time, they do not respond as quickly to changes in the federal funds rate.
Instead, they typically track the performance of the yield on the 10-year Treasury bill, a debt issued by the federal government to finance its spending and debt that matures in 10 years. Since most homeowners only hold their mortgages for about ten years, mortgage rates are tied to the following note: When yields rise, so do rates. Treasury bonds, in turn, are affected by economic conditions and investor behavior.
The reason rates fell before rather than after the September rate cut had more to do with investors’ expectations about inflation and the strength of the U.S. economy than with the central bank’s actions, said David Berson, chief U.S. economist at investment firm Cumberland Advisors.
In the months leading up to the rate cut, the economy was sending signals that it was cooling: Inflation was trending downward, job growth was slowing and unemployment was rising. These signals, in turn, increased the likelihood that the Fed would cut rates to avoid a recession and achieve a gradual soft landing.
As the likelihood of an initial cut in September—plus another one or two before the end of the year—increased, mortgage lenders began factoring the Fed’s move into their rate proposals, cutting mortgage rates before anything happened.
Essentially, lenders factored in the cut before the Fed acted based on their expectations of what the central bank would do.
However, after the rate cuts, those same economic indicators began to point to a more resilient economy than expected. The September jobs report was hotter than forecast, and other financial data such as retail sales, wage growth and unemployment pointed to economic growth rather than a slowdown.
Berson said the strong economic data has prompted a shift in market expectations: Perhaps inflation will rise, people speculate, or the Fed won’t cut rates as much as previously thought. The result is higher mortgage rates because “that’s what happens when the economy appears to be stronger than expected,” Berson says.
So, while the Fed does influence interest rates, the effect of lowering rates, particularly on mortgages, is not immediately felt. That doesn’t mean mortgage rates won’t fall if the central bank continues to cut the federal funds rate—eventually they will. It’s just that in the meantime, the economy will really determine the direction of rates.
How could a Trump presidency affect mortgage rates?
Federal budget deficits also affect Treasury yields because these bonds are used to pay interest on the debt. The higher the debt, the more yields must rise to attract investor interest.
A second term for President-elect Donald Trump could add between $1.65 trillion and $15.55 trillion to the deficit over the next 10 years, according to the Committee for a Responsible Federal Budget. That could lead to more rate volatility in the coming months, according to Lisa Sturtevant, chief economist at Bright MLS.
After the election results were announced, the yield on the 10-year Treasury note jumped from 4.258% to nearly 4.5%. They are rising, Sturtevant said in emailed comments, “because investors expect Trump’s proposed fiscal policy to increase the federal deficit and reverse progress in inflation.”
If consumer prices rise significantly, it could mean the end of the Fed’s rate cuts or even a rate hike. Depending on whether these forecasts pan out, Treasury yields and subsequent mortgage rates could end up being higher than anyone expects.
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