There was again no change in the federal funds rate for a seventh consecutive meeting, which is still holding steady at a range of 5.25% to 5.5%. The key policy rate remains at its highest level since late January 2001, and the Fed provided no specific guidance as to when any change in this rate will come.
The federal funds rate was last increased in July 2023, and with the next Fed meeting not coming until late July, the federal funds rate will end up having held its present level for a full years' time, and likely longer, given low odds of a change in rates next month.
The timing of the first decrease in short-term interest rates is no clearer today than it was yesterday. The Fed again did not give investors what they hoped to hear -- there was no explicit language outlining expectations for lowering rates anytime soon -- and in fact, once again the message was that "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent."
As recently as March, the official Fed outlook suggested a chance of up to three cuts in interest rates this year. This has now changed. Inflation did not remain on a downward trajectory early in 2024 as it did in late 2023, and the June update to Fed members Summary of Economic Projections (SEP) now pencils in just one or perhaps two rate cuts in 2024.
If rate cuts are still in the cards for this year, the timing of them may be complicated by the November presidential election cycle. Given the schedule of FOMC meetings (and if inflation reports should turn more favorable between now and then) a September cut would likely be the best near-term opportunity. However, the Fed typically does not prefer to make changes to interest rates close to a presidential election. Should they defer at that time, the November FOMC meeting comes fast on the heels of the presidential election, making it a potential point for a move.
At the same time, whenever they do start lowering policy rates, there's little reason to think that the Fed will be looking to make cuts at successive meetings, particularly at the start of a new interest rate cycle. With this in mind, and as there are just four remaining get-togethers this year, we presume July is not "in play" for a rate cut, even if there is additional positive news on inflation by that time. That leaves three remaining 2024 opportunities, and the Fed at this moment seems likely to only act on perhaps one of them, or two at most, unless there is a significant deterioration in the economic climate, or in labor markets, or if inflation should suddenly retreat further.
To be fair, the economy at the moment doesn't seem to need the additional support that a rate cut will provide. Although the initial reading for GDP growth to start 2024 showed a considerable downshift from the end of 2023, the Fed again stated that "Recent indicators suggest that economic activity has been expanding at a solid pace," per the statement that closed the latest meeting. GDP growth started 2024 with a 1.25% rate of GDP growth (final revision forthcoming) and current estimates for growth in the second quarter of 2024 puts GDP at a 3.1% pace, per the Atlanta Fed's GDPNow model.
It's also true that inflation continues to run at a level pretty well above the Fed's target. However, the Fed continues to point to progress being made on inflation: "Inflation has eased over the past year but remains elevated" continues to be the official statement. To this repeated statement, the Fed has now added that "In recent months, there has been modest further progress toward the Committee's 2 percent inflation objective." This is a slight improvement in the outlook when compared against the May 1 statement of "a lack of further progress" being made.
Tight labor markets remain are also on the Fed's mind, of course. The statement noted "Job gains have remained strong, and the unemployment rate has remained low," and this despite the unemployment rate ticking up to 4% in May, the highest it has been in about three years. Mr. Powell's prepared remarks noted that "The labor market has come into better balance, with continued strong job gains and a low unemployment rate."
In recent weeks, we have learned that job openings leveled off in April, as have voluntary and involuntary separations, while hiring kicked higher again in May after a comparatively moderate April gain. As well, wage growth has remained fairly firm at a level above that which the Fed feels is consistent with inflation returning to the 2% level it desires.
Mr. Powell did note that "If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we are prepared to respond."
Odds of Fed rate decreases
Fed's Chair Powell's prepared remarks said that "We are maintaining our restrictive stance of monetary policy in order to keep demand in line with supply and reduce inflationary pressures."
With this in mind, the July 2023 increase in the federal funds rate seems to be the last hike for this cycle. Although it may be restrictive, the current level for the federal funds rate may or may not be sufficient to drive inflation back down to the 2% "core PCE goal the central bank has set, or at least do so very quickly. Even absent any additional hikes, this key rate has already remained elevated for a fair period of time but will now remain there for a year or longer. This might put the first decrease in rates in the middle of September, but should that be skipped and it could be December before a change occurs.
The June 2024 update of the Summary of Economic Projections (SEP) revealed that Fed members expected just one or perhaps two quarter-point decreases in the federal funds rate by year end, a change from the three they expected as recently as March.
Now June, the median expectation for the level of the federal funds at the end of 2024 is 5.1%, up from the 4.6% forecast in March. There was also another change in the outlook for 2025; in June, Fed members saw a federal funds target rate in 2025 of 4.1%, so roughly a forecast of four cuts in rates next year, but this expected final level for the key monetary policy rate is up from 3.9% in March. Even as rates are expected to decline, they are now forecast to do so more slowly. This continues a stated policy of "higher rates for longer" expressed in the policy outlook at times over the last year or so.
Looking forward into the future, the mid-term outlook for rates was unchanged from March, with a 3.1% funds rate expected at the end of 2026. However, the expectation for the longer-run rate was raised again, and is now 2.8%; this long-range forecast has been raised in each of the last three SEP reports. That said, these two-year and beyond outlooks are less forecasts and more speculation, as anything can happen over this kind of time horizon.
While it's both hopeful and encouraging for potential borrowers that rates will likely be lower at some point this year, it's also important to temper that enthusiasm. The reality is that even if there are two cuts in rates in 2024, even a 4.8% median federal funds rate would only return it to about where it was as recently as March 2023... and this would still be as high as this rate was back in late 2006 - early 2007. As such, this key short-term rates would move only from about 23-year highs back down to the equivalent of 17 or 18 year highs. The cost of money will be cheaper, but still by no means cheap.
The next Fed meeting comes in late July (30th & 31st). Prior to this meeting, futures markets reckoned only about a 14% chance that the first cut in rates will come then; post-meeting, this was probability dropped to only about 8% or so.
What has changed is investor expectations for the path of policy for the remainder of 2024. When the year began, as many as six cuts in rates were forecast for this year. With nearly half of the year gone by, no change in rates has yet come, and looking forward, federal funds futures investors place only about a 60% probability for a quarter-point cut in September, about a 75% chance that a cut will be in place by November, but a majority of futures-markets speculators still think that a second cut will come by the close of the December meeting.
While it is still most likely that the first cut to rates will come in September, we're still of the mind -- and the Fed may be yet, too -- that core inflation will need to at run below the 3% mark for a while before the first rate cut get serious consideration. Core PCE cracked this level in December 2023 and has even managed to trend down to an annual 2.7% rate through April. That said, core inflation was firmer in early 2024, but recently eased gently, and in fact is running at just about the Fed's new SEP forecast of 2.8% for the whole of 2024. However, it would appear that even this improvement in inflation hasn't yet instilled in the Fed the kind of confidence it needs to cut rates anytime soon.
Fed's "balance sheet" trends
In addition to raising rates, the Fed is continuing the process of "significantly" reducing its balance sheet and is now trying to retire $35 billion of MBS and $25 billion (formerly $60b) of Treasury debt from its investment portfolio each month. Higher market-engineered mortgage rates over the last year crushed refinancing, slowed mortgage market activity considerably, and softened housing markets appreciably.
Achieving desired levels of portfolio runoff of mortgage holdings may eventually see the Fed need to conduct outright sales of MBS. With mortgage rates high, home sales slow and refinancing at a virtual standstill, the current rate of MBS runoff was and is highly likely to run below desired levels, and has been since the runoff program began 24 months ago.
The general process of balance-sheet reduction is accomplished by no longer using the proceeds of inbound interest and principal payments from the Fed's existing holdings to buy more bonds. As such, reductions in holdings are happening as borrowers whose mortgages make up those MBS pay down their loan balances, which any homeowner knows is a slow process.
As of June 5, the Fed held $2.355 trillion in mortgage paper, down from $2.707 trillion when the QT program began in June 2022, so the reduction isn't happening at the pace the Fed has hoped. By design, some $857.5 billion should have been trimmed from Fed MBS holdings by the end of June, but the decline has only been about $353 billion so far, less than half of what the Fed was hoping to see. MBS holdings will decline faster as mortgage rates decline and refinancing activity picks up. The Fed's present holdings of MBS are at a level they thought would have occurred back in April-May 2023, so the process of reduction is more than a year behind schedule.
It's not known (the Fed may not even know at this point) what size the balance sheet will need to be in the Fed's "ample reserves" monetary regime. If we assume that the central bank was comfortable with the size of the balance sheet pre-pandemic, this would be total holdings of about $4 trillion, so they would need to achieve about $5 trillion in reduction over some period of time.
As of April 24, the total Fed balance sheet was about $7.255 trillion, so despite reducing its holdings by more than $1.7 trillion, there remains a ways to go if the goal is to return to a pre-pandemic level. Beginning in June, reductions in Treasury holdings will be limited to $25 billion per month, while MBS reductions will remain at $35 billion. Redemptions of mortgages have not yet hit this cap in the balance-sheet reduction regime, but when they do, any redemptions in excess will be used to buy up more Treasury bonds rather than more MBS.
The Fed's next scheduled meeting comes July 30-21. It seems highly unlikely that a change in the federal funds rate will come at that time, and there is no update to the Summary of Economic Projections due at that time. After that, it's probably "see you in September", as the old song goes.
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 change to this rate by the Federal Reserve came on July 26, 2023 and was the eleventh increase in the funds rate since 2018, when the Fed last completed a cycle of increasing interest rates. The current 5.5% rate is the highest it has been since January 31, 2001.
By the Fed's recent thinking, the long-run "neutral" rate for the federal funds is perhaps 2.8 percent or so, a level well below what has long been considered to be a "normal" level. The Fed has raised the federal funds rate well above this normal level in order to temper inflation pressures that rose to more than 40-year highs in 2022. Once the Fed cycle of increases is complete, short-term rate may be slow to retreat to the Fed's "long-run" 2.8% rate. As of June 2024, the central bank's own forecast doesn't expect for it to return there until 2027 at the very earliest.
The Fed can either establish a range for the federal funds rate, or may express a single value for its key monetary policy tool.
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 and markets liquid.
This recycling of inbound funds lasted until June 2017, when the Fed announced that the process of reducing its so-called "balance sheet" (holdings of Treasuries and MBS) would start in October 2017. In a gradual process, the Fed in steps reduced the amount of reinvestment it was making until it eventually was 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 through December 2018.
In 2019, the Fed decided to begin winding down its balance-sheet-reduction program with a termination date of October. With signs of some financial distress showing in financial markets due to a lack of liquidity, the Fed decided to terminate its reduction program two months early.
For that run, the total amount of runoff ended up being fairly small, and the Fed was still left with huge investment holdings. At the time, the Fed's balance sheet was comprised of about $2.08 trillion in Treasuries and about $1.52 trillion in mortgage-related debt. Although no longer reducing the size of its portfolio, the Fed began to manipulate its mix of holdings, using inbound proceeds from maturing investments to purchase a range of Treasury securities that roughly mimicked the overall balance of holdings by investors in the public markets.
At the same time, up to $20 billion each month of proceeds from maturing mortgage holdings (mostly from early prepayments due to refinancing) were also to be invested in Treasuries; any redemption over that amount was be used to purchase more agency-backed MBS. Ultimately, the Fed prefers to have a balance sheet comprised solely of Treasuries obligations, and changing the mix of holdings from mortgages to Treasuries as mortgages were repaid was expected to take many years. But these well-considered plans didn't last.
Then came the pandemic. In response to turbulent market conditions from the COVID-19 pandemic, the Fed re-started QE-style purchases of Mortgage-Backed Securities in March 2020, so not only did the slow process of converting MBS holdings to Treasuries come to a halt, the Fed was again actively buying up new MBS, growing their mortgage holdings. Through October 2021, MBS purchases were running at a rate of $40 billion per month, and any inbound proceeds from principal repayments existing holdings were being reinvested in additional purchases. As economic conditions settled, MBS bond buys were trimmed to $30 billion per month starting in December 2021 and then to $20 billion per month in January 2022 and it was expected that a similar pace of reduction going forward would occur.
Since the Fed's restart of its MBS purchasing program in March 2020, it had by mid-April 2022 added more than $1.37 trillion of them to its balance sheet. Total holdings of MBS topped out at about $2.740 trillion dollars, and the Fed's mortgage holdings had doubled since March 2020.
The Fed has since concluded its bond-buying program. The start of a "runoff" process to reduce holdings was announced at the close of the May 2022 meeting and began in June 2022 Reductions of $17.5 billion in MBS in the first three months of the program increased to $35 billion per month in September 2022, and desired reductions in holdings remain at this pace today, but market redemptions remain well short of this goal.
What is the effect of the Fed's actions on mortgage rates?
Mortgage interest rates began cycling higher well in advance of the first increase in short-term interest rates. This is not uncommon; inflation running higher than desired in turn lifted expectations that the Fed would lift short-term rates, which in turn has lifted the longer-term rates that influence fixed-rate mortgages. Persistent inflation has reinforced this cycle.
The reverse of the above is also true. Mortgage rates decreased considerably from peak levels, as an improved outlook for price pressures, loosening labor market conditions and cooling economic growth all suggest that the Fed's cycle of increases has done its job, and that before long, lower short-term rates will be coming.
Also important for this new cycle, is that the Fed is no longer directly supporting the mortgage market by purchasing Mortgage-Backed Securities (which helps to keep that market liquid). This means that a reliable buyer of these instruments -- and one that did not care about the level of return on its investment -- has left the market.
This leaves only private investors to buy up new MBS, and these folks care very much about making profits on their holdings. Add in a range of risks to the economy -- including such things as the potential for softening home prices and this may make them more wary of purchasing MBS, even at relatively high yields. With the Fed also no longer purchasing Treasury bonds to help keep longer-term interest rates low, the yields that strongly influence fixed mortgage rates also rose, and may also be slower to decline than they have been in recent years.
What the Fed has to say about the future - how quickly or slowly it intends to raise rates or lower rates this year and beyond - will also determine if mortgage rates will rise or fall, and by how much. At the moment, and given the Fed's new long-term policy framework, the path for future changes in the federal funds rate is of course uncertain, but the current expectation is that the eleven increases in the federal funds rate so far are now less likely to be joined by others yet in the current cycle. As such, the coming Fed interest rate cycle should be one of declining rates over time.
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 at near zero until March 2022, but fixed mortgage rates rose by better than three quarters of a percentage point in the months the preceded the March 17 increase. Rates increased amid growing economic strength and a increasing concern about broadening inflation pressures.
A more recent example also shows the converse effect. The Fed last raised rate in July 2023 held them steady through April 2024. Over that time, mortgage rates rose by, and then declined by, more than a full percentage point. All this change in mortgage rates happened while the Fed stood idly by.
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.
The prime rate usually increases or decreases within a day or two of a change in the federal funds rate.
Related content: Fed Funds vs. Prime Rate and Mortgage Rates
After a change to the federal funds rate, 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. We saw this as recently as 2018; after the ninth increase in the federal funds rate over a little more than a two-year period, economic growth began to stall, inflation pressures waned, and mortgage rates retreated by more than a full percentage point. The most recent episode of declining mortgage rates during the end of 2023 and start of 2024 also demonstrates this point.
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 or holding them steady. 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 our analysis of Federal Reserve Policy and Mortgage Rate Cycles.
