Mortgage rates are down! It may be a good time to refinance, or learn the income you need to buy a median-priced home in the top 50 metro areas!

Mortgage rates are down! It may be a good time to refinance, or learn the income you need to buy a median-priced home in the top 50 metro areas!

HSH.com on the latest move by the Federal Reserve

At the close of its late July meeting, the Federal Reserve decided cut the federal funds rate by 25 basis points (0.25%), moving the target range for the Fed's key policy tool to 2% to 2.25%. This is the first cut in the federal funds rate since 2008, but returns it to where it was last September.

Citing "the implications of global developments for the economic outlook as well as muted inflation pressures," the Fed felt compelled to move even though the domestic economy is doing very well, with a strong labor market, solid consumer spending and very high stock valuations. "Growth of business fixed investment has been soft," said the Fed, and it is in this area that it hopes to inject some confidence.

Although the global economy is beyond the Fed's purview, there is little doubt that the disruption of trade from the imposition and/or threat of tariffs have dinged other developed economies. To be sure, a lower federal funds rate can do little to combat erratic trade policies, but does signal that the world's most important central bank will do what it can to help keep growth going. Growth in China, Germany, Japan, the Eurozone and elsewhere have all downshifted of late, and central banks around the globe are taking steps to address this sluggishness, mostly by cutting rates. This past week, the European Central Bank intimated that its already-negative policy rate may go lower and that a new round of bond buying (QE) may be implemented before long.

Although the Fed noted that inflation remains muted, the most recent data for the Fed's preferred measure of prices says otherwise. The "core" measure of Personal Consumption Expenditures had been running at just a 1.1% clip in the first quarter of 2019 but flared to 1.8% in the second. perhaps reflecting price pressures the Chairman Jay Powell described last year as "transitory". Whatever the case, inflation is moving closer to the Fed's 2% target of late.

With a pretty solid economy in place, not all FOMC members thought that the funds rate should be cut; the vote was 8-2, with two participants preferring to leave the funds rate untouched.

Two other policy moves were made at the meeting, one common and one not. Along with the reduction in the federal funds rate, the Fed also trimmed the rate it pays to banks for depositing excess reserves, and the IOER rate was moved to 2.10%. At the same time, the Fed ended its balance-sheet runoff process two months early; now, inbound proceeds from Treasuries will all be reinvested in to new ones, spread along the yield curve, as will inbound payments on mortgages and mortgage-related debt up to $20 billion per month, with anything over this redemption amount being used to buy more agency and MBS debt. High refinancing activity may see this happen as the year progresses, providing a least a little support to keep mortgage rates low.

Futures markets aren't convinced that this so-called "insurance" cut in the funds rate will be a one-and-done affair. The odds of another cut come September are currently reckoned at better than 70%, but there is a lot of time and data to be absorbed between now and then. The Committee's statement that closed the meeting was vague in this respect, though, and said only that "As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective."

If labor markets remain strong with solid hiring each month and a near-50-year low unemployment rate while core PCE inflation holds at about present levels we think that investors betting on another rate cut just six weeks from now are likely to be disappointed. It will be instructive to follow various comments and speeches from Fed officials between now and then to see if they try to subtly (or overtly) move market expectations away from another rate cut. An opening salvo may have come from Chairman Powell; at the press conference after the meeting, he characterized the move today as a "mid-cycle adjustment."

The next FOMC meeting comes September 17-18.

For what it's worth, place us with the dissenters above. We didn't think that the economy needed a cut at this meeting but recognize the pressure the global economy, investors and the President put on the Fed, who likely painted itself into a corner since the June meeting and so felt that it had to cut rates. It's true that the economy has cooled from the 2018 stimulus provided by the tax cut and is challenged by the trade mess, but growth at about 2.1% and core inflation at about 1.8% combined with other corroborating evidence of growth don't suggest that lower interest rates were especially warranted right now.

On a longer-term basis, it looks as though that this particular Fed interest-rate cycle has at least paused (if not altogether ended) with rates well below historic norms. Expectations for the federal funds rate in the June Summary of Economic Projections (SEP) indicate that Fed members see a long-run rate (post-2021) of just 2.5%, a figure pulled down by 0.3% since the March meeting. The current expectation for this year remained at 2.4%, but the outlook suggests at least one and perhaps two cuts in the key policy rate in 2020, with the median outlook ratcheted down to 2.1% for that horizon from 2.6% in March. The next updated SEP comes with the September meeting.

With the latest move of the federal funds rate putting it in a range of 2 percent to 2.25 percent, the cycle of interest rate increases is done, for now. Whether the upcycle for rates will resume is unclear at the moment. That said, with long-run projections for the funds rate now above today's levels, it should be noted that the Fed's 2.5% forecast for the longer run isn't necessarily the peak possible interest rate over time, but rather an annual average that may be tempered by future conditions, where rates have started moving down as a result of a worsening economic climate. Indeed, the projections suggest that peak rates already be in place, and may decline in 2020 and re-firm a bit come 2021.

What is the federal funds rate?

The federal funds rate is an intrabank, overnight lending rate. The Federal Reserve increases or decreases this so-called "target rate" when it wants to cool or spur economic growth.

The last Fed move on July 31, 2019 was the first decrease in the funds rate since 2008, when the Fed moved the rate to nearly zero. As Fed Chairman Powell characterized the move as a "mid-cycle adjustment", it's not clear whether this is a temporary retreat in a still-ongoing cycle of increases or if it may be followed up with additional cuts. Mr. Powell said Fed officials weren’t ruling out additional rate reductions, but neither did officials view Wednesday’s action as "the beginning of a long series of rate cuts."

By the Fed's current thinking, the long-run "neutral" rate for the federal funds may be as low as 3 percent, so even as rates do rise over time, they may not get close to historic "normal" levels.

The Fed can either establish a range for the federal funds rate, or may express a single value.

Related content: Federal Funds Rate - Graph and Table of Values

How does the Federal Reserve affect mortgage rates?

Historically, the Federal Reserve has only had an indirect impact on most mortgage rates, especially fixed-rate mortgages. That changed back in 2008, when the central bank began directly buying Mortgage-Backed Securities (MBS) and financing bonds offered by Fannie Mae and Freddie Mac. This "liquefied" mortgage markets, giving investors a ready place to sell their holdings as needed, helping to drive down mortgage rates.

After the program of MBS and debt accumulation by the Fed ended, they were still "recycling" inbound proceeds from maturing and refinanced mortgages to purchase replacement bonds for a number of years. This kept their holdings level and provided a steady presence in the mortgage market, which helped to keep mortgage rates steady.

In June 2017, the Fed announced that the process of reducing its so-called "balance sheet" (holdings of Treasuries and MBS) would start in October 2017. In this gradual process, the Fed will trim back the amount of reinvestment it is making in steps until it eventually is actively retiring sizable pieces of its holdings. When the program was announced, the Fed held about $2.46 trillion in Treasuries and about $1.78 trillion in mortgage-related debt. It had been reducing holdings at a set amount and was on a long-run pace of "autopilot" reductions as recently as December 2018.

Earlier this year, the Fed decided to begin winding down its balance-sheet-reduction program with a termination date of October, but as of August 2019 decided to stop reducing its holdings altogether, ending the program two months early. As the total amount of balance sheet runoff was fairly small, the Fed will be left with a huge set of investment holdings, presently comprised of about $2.08 trillion in Treasuries and about $1.52 trillion in mortgage-related debt. Starting August 1, all inbound proceeds from maturing investments will be used to purchase more Treasury securities of various maturities to roughly mimic the overall balance of holdings by investors. As well, up to $20 billion each month of proceeds from maturing mortgage holdings (mostly from early prepayments due to refinancing) will also be invested in Treasuries; any redemption over that amount will be used to purchase more agency-backed MBS. Ultimately, the Fed wishes to have a balance sheet comprised solely of Treasuries, but changing the mix of holdings from mortgages to Treasuries as mortgages are repaid will take many years.

In general, the Fed will continue to be a buyer of newly-issued Treasury debt, which should keep some downward pressure in overall interest rates, but will generally not be a buyer of MBS, so what happens to mortgage rates will again be more fully at the whims of investors in these securities. Of course, the Fed can certainly change balance-sheet policies in the future, as warranted.

Some analysts reckoned that the original expected program of divestiture/runoff of Treasuries and mortgages would make fixed-rate mortgages perhaps a quarter percentage point higher than they would otherwise have been in "normal" market conditions. With the program terminating early and with the Fed remaining a considerable buyer of Treasuries and perhaps mortgages (at times), this new phase of the Fed's balance-sheet management program is expected to have only a modest direct effect on mortgage rates,

Will mortgage rates rise, and why?

For this cycle, and for the moment, more important than any small change in the overnight rate is that the Federal Reserve has stepped away from actively and directly supporting the mortgage market though purchases Mortgage-Backed Securities (MBS) and Treasuries. The effects of this process will eventually lift mortgage rates somewhat, and private investors will have to pick up increasing amounts of these bonds. With an unexpected decline in mortgage rates happening in 2019, refinance activity has again kicked higher and home sales have firmed a little bit of late, so there may be some additional bond supply that investors will need to absorb, which may help to firm rates at some point. That said, the supply of new MBS remains fairly low, helping temper expected increases in mortgage rates.

The Fed has a massive portfolio of these investments and as they mature or have been paid off (by refinancing) the central bank had been re-investing the inbound funds into more purchases, keeping its portfolio at a constant size. After a period of drawing down its holdings, the Fed is again actively recycling inbound proceeds from its holdings in to new purchases of Treasuries, and possible mortgages if market conditions warrant. The resumption of the reinvestment program means that a large regular buyer of these instruments will be a regular presence in the market. While a stabilizing factor, the prospects for inflation and continued economic expansion will play a greater role in dictating how interest rates will move.

What the Fed has to say about the future – how quickly or slowly it intends to raise rates or lower rates in 2019 and beyond – will also determine if mortgage rates will rise, and by how much. At the moment, the path for future changes in the federal funds rate is uncertain; even with the first decline in more than 10 years breaking a string of nine increases, the future for monetary policy is very murky at the moment and there is certainly no unanimity in thinking among Fed policy makers as to their future direction.

HSH.com Federal Reserve Policy Tracking Graph

Does a change in the federal funds influence other loan rates?

Although it is an important indicator, the federal funds rate is an interest rate for a very short-term (overnight) loan. This rate does have some influence over a bank's so-called cost of funds, and changes in this cost of funds can translate into higher (or lower) interest rates on both deposits and loans. The effect is most clearly seen in the prices of shorter-term loans, including auto, personal loans and even the initial interest rate on some Adjustable Rate Mortgages (ARMs).

However, a change in the overnight rate generally has little to do with long-term mortgage rates (30-year, 15-year, etc.), which are influenced by other factors. These notably include economic growth and inflation, but also include the whims of investors, too. For more on how mortgage rates are set by the market, see "What moves mortgage rates? (The Basics)." 

Does the federal funds rate affect mortgage rates?

Whenever the Fed makes a change to policy, we are asked the question "Does the federal funds rate affect mortgage rates?"

Just to be clear, the short answer is "no," as you can see in the linked chart.

That said, the federal funds rate is raised or lowered by the Fed in response to changing economic conditions, and long-term fixed mortgage rates do of course respond to those conditions, and often well in advance of any change in the funds rate. For example, even though the Fed was still holding the funds rate steady in autumn 2016, fixed mortgage rates rose by better than three quarters of a percentage point amid growing economic strength and a change in investor sentiment about future growth and tax policies during the period.

What does the federal funds rate directly affect?

When the funds rate does move, it does directly affect certain other financial products. The prime rate tends to move in lock step with the federal funds rate and so affects the rates on certain products like Home Equity Lines of Credit (HELOCs), residential construction loans, some credit cards and things like business loans. All will generally see fairly immediate changes in their offered interest rates, usually of the same size as the change in the prime rate or pretty close to it. For consumers or businesses with outstanding lines of credit or credit cards, the change generally will occur over one to three billing cycles.

Related content: Fed Funds vs. Prime Rate and Mortgage Rates

After a change to fed funds, how soon will other interest rates rise or fall?

Changes to the fed funds rate can take a long time to work their way fully throughout the economy, with the effects of a change not completely realized for six months or even longer.

Often more important than any single change to the funds rate is how the Federal Reserve characterizes its expectations for the economy and future Fed policy. If the Fed says (or if the market believes) that the Fed will be aggressively lifting rates in the near future, market interest rates will rise more quickly; conversely, if they indicate that a long, flat trajectory for rates is in the offing, mortgage and other loan rates will only rise gradually, if at all. For updates and details about the economy and changes to mortgage rates, read or subscribe to HSH's MarketTrends newsletter.

Can a higher federal funds rate actually cause lower mortgage rates?

Yes. At some point in the cycle, the Federal Reserve will have lifted interest rates to a point where inflation and the economy will be expected to cool. As the market starts to anticipate this economic slowing, long-term interest rates may actually start to fall even though the Fed may still be raising short-term rates. Long-term rates fall in anticipation of the beginnings of a cycle of reductions in the fed funds rate, and the cycle comes full circle. For more information on this, Fed policy and how it affects mortgage rates, see “Federal Reserve Policy and Mortgage Rate Cycles ."

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