The Federal Reserve has finally started to cut its federal-funds rate. And if you've been following along, you might have noticed something odd happening...
Normally, when the Fed cuts rates, we would expect mortgage rates to come down, too. But this time, the opposite is happening. Mortgage rates have actually climbed since the Fed's decision.
This unexpected move has many scratching their heads. Folks assumed that with a lower cost of short-term borrowing, mortgage rates would also decline.
So today, we'll examine the moving parts that determine mortgage rates – and explain the recent surprising move...
As a reminder, the fed-funds rate is the interest rate that banks charge each other to borrow money overnight. It's also referred to as the "overnight" rate.
When the Fed cuts this rate, it becomes cheaper for banks to lend to each other... And it should lead to lower borrowing costs across the board, including for consumers.
This often causes a ripple effect that can lower interest rates on things like car loans, credit cards, and mortgages.
Now, mortgage rates don't always follow the fed-funds rate exactly. Instead, mortgage rates are influenced by a combination of factors.
Still, what has happened is a surprise to many...
Since the Fed cut its benchmark lending rate by half a percentage point in September, both the 10-year U.S. Treasury yield and mortgage rates have climbed significantly. Take a look...
The thing is, financial markets by definition are always forward-looking. They're trying to predict what's coming next.
So, when it became clear that the Fed would start cutting rates, investors adjusted their expectations in advance. In other words, by the time the Fed actually acted, much of the expected impact was already "baked into" market rates.
Mortgage rates didn't drop further because the market had already anticipated the cuts. And other forces – like worries about inflation, government deficits, the upcoming election, and the global economic outlook – have started to push rates higher again.
Investors have started to demand higher returns to hold longer-term bonds, which has also pushed mortgage rates up.
And while it's true that mortgage rates have risen after the Fed's cut, it's important to zoom out and remember that they're still down from the high of 7.8% we saw this time last year.
If we take a step back, we can see that rates have come down significantly from their recent peaks...
This recent rise in mortgage rates, even amid Fed cuts, highlights an essential point: Mortgage rates respond to a complex blend of economic signals – not just Fed policy.
For example, investors often demand higher yields when they're expecting hot economic growth... or higher inflation.
So, yes, the Fed does have some influence on different interest rates. But the broader bond market and investor sentiment around economic risk and inflation tend to play a larger role, especially for longer-term rates like mortgages.
Right now, everyone's worried about what this means for housing. But while rates may have climbed since the last Fed cut, they're still below their recent peaks. It's a better market for homebuyers today than it was a year ago. And mortgage rates could ease further if the broader economic outlook stabilizes and inflation continues to die down.
That means we need to watch more than just the Fed. Indicators such as inflation, economic growth metrics, and government spending patterns are important, too.
In short, the September rate cut is a good reminder that the path for mortgages isn't necessarily straightforward...
Markets are always one step ahead. They price in expectations long before we see an official policy move. The Fed's actions often grab the headlines... But to make informed decisions, always keep an eye on the bigger picture.
Good investing,
Andrew McGuirk
Further Reading
"Don't get hung up about whether rate cuts will pause in November," Marc Chaikin writes. The current bull market turned two years old last month. That's roughly the midpoint of the median bull market going back to 1950. And it's one reason why stocks should keep rising... Read more here.
No matter the market environment, interest rates are a key driver of asset prices. And while it's impossible to time interest rates perfectly, we can predict how the "gravity of finance" will affect our investments... Learn more here.
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