Completely Fed Up

 

Scott Lawson – 9/17/2024

As you probably know already, tomorrow is “Fed” day when the Federal Reserve is expected to lower interest rates. Please keep in mind and educate your clients that mortgage rates may or may not do what you expect because:

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  • The Fed controls Fed Funds rates only
  • Mortgage rates are driven by investors (the market) and not the government
  • Mortgage rates lead the Fed in both directions
  • Much of the mortgage rate downside may already be “baked into the cake”

First, the primary tool used to fight inflation and thwart recession for the Federal Reserve is manipulating the Federal Funds Rate—the interest rate that banks borrower from one another at. As they (The Fed) drain liquidity from our monetary system to fight inflation, the Fed Funds rate goes higher—sometimes significantly higher. Banks then adjust the Prime Rate in lock step with the Fed Funds Rate. This affects personal loans, commercial loans, credit cards, auto loans and even home equity loans. The higher they push, the more expensive debt becomes and the more our system slows down.

Next, mortgage rates are not directly influenced by the Fed. Supply and investor demand determine this one. The last increase by the Fed was over a year ago (July 2023). Since then, we’ve seen 8%+ mortgage rates down to more recent rates in the high 5’s. All of this variability without the Fed having done anything—no raising and no lowering. The public view that the Fed is about to lower mortgage rates makes absolutely no sense according to how our economic system operates.

Further, the longer-dated maturity bond market will always lead the Fed—which is typically just along for the ride. The decline in mortgage rates started the week of October 23, 2023. The markets base bond rates on required rates of return relative to inflation and other risk factors. This started almost a year ago and only now is the Fed about to act. They always follow, never lead.

Lastly, this is the first reduction in the Fed Funds Rate since March of 2020. The market has been anticipating this and has rallied aggressively into tomorrow’s decision by the Federal Reserve. Whether it’s a quarter point or a half a point makes no difference. I sense a pretty good possibility of a counter move in the bond market—a “sell the news” situation, which could lead to higher, not lower mortgage rates in the very short term. This is by no means a prediction, just a “don’t be surprised if the market confounds everyone” scenario.

To sum it up, the “knee jerk” reaction really won’t mean anything as the weeks go by—if it happens at all. I fully expect mortgage rates to at least see the low 5’s in the coming months—and that is something to look forward to…

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