What the Fed’s action could mean for mortgage interest rates

It’s bad enough that Southern California home prices remain high despite cooling demand, averaging nearly seven times the state’s median income for a family of four.

Worse still, the rapid rise in mortgage interest rates. The rate on a 30-year fixed-rate mortgage has doubled in nine months, topping 6% last week for the first time since George W. Bush’s presidency.

It’s painful not only for people trying to borrow money to buy a home, but also for homeowners with adjustable rate mortgages, whose monthly payments increase every year when interest rates rise.

Two factors for the increase were inflation and the efforts of the Federal Reserve Board of Governors to control it. The Fed has raised the short-term “federal funds” rate (the interest banks charge each other for overnight loans) four times this year, and is expected to do so again on Wednesday.

David Wilcox, senior economist at the Peterson Institute for International Economics and Bloomberg Economics, said a key driver of mortgage interest rates is the level of inflation lenders expect to see over the life of the loan. And given the messages from the Fed and continued inflationary pressures in the economy, financial markets are expecting a higher interest rate trajectory in the coming years than at the start of 2022.

So should you expect to pay even more for a new mortgage after the Fed imposed its latest increase? Maybe, but there is no simple cause and effect here. Instead, the Fed’s actions indirectly affect mortgage rates by influencing the expectations of lenders and financial markets.

Consider what happened after the Fed raised its target interest rate by 0.75 percentage points in June, the biggest increase since 1980: mortgage rates fell. They started to climb again a few weeks later in anticipation of the Fed meeting in July, when it raised its target by 0.75 percentage points for the second time. And after that, mortgage interest rates fell again.

This illustrates how financial markets are running ahead of the Fed, reacting to expectations rather than waiting for the central bank to act. And when the Fed meets those expectations, “you usually see some sort of recovery,” said Robert Heck, vice president of mortgages at Morty, an online mortgage broker.

The Fed is trying to break the inflation fever in the economy without plunging the country into a recession, but the usual indicators of economic health are confusingly intertwined. Gross domestic product plummets, but unemployment remains low; corporate earnings are largely solid; consumer confidence is picking up; and consumer spending continues to grow, albeit slowly.

Fed Chairman Jerome H. Powell has repeatedly said that the Fed will raise interest rates until inflation is brought under control. Still, some lenders and investors looked at the economy in July and thought the Fed would ease off the monetary brakes, Heck said.

That changed in August, however, when Powell and other Fed officials reiterated their determination to, as Powell said on August 26, “continue until we are satisfied the job is done.” . Deliberately or not, the statement echoed the headline from the memoirs of former Fed Chairman Paul Volcker, who used high interest rates to pull the United States out of double-digit inflation in the 1980s. .

“I think the Fed has been able to communicate more clearly and the market has taken more and deeper into its determination to fight inflation and win the battle,” Wilcox said.

At the same time, Wilcox said, “the market has concluded that the Fed will have to do more to win this fight.”

Recent data shows that inflation is broader and more tenacious than previously thought, and the labor market continues to be “extraordinarily robust”, he said.

Neither of the recently released economic data points to an interest rate cut, Heck said.

Hence the constant rise in mortgage interest rates since early August.

Another reason for the increase, Heck said, was speculation that the Fed might raise the federal funds rate by an even larger amount on Wednesday — by 1 to 1.25 percentage points. “I think this meeting is probably the one we were least prepared for, in terms of knowing what’s going to happen,” Heck said.

One key to the market’s reaction will be the “dot chart,” or the chart showing how much Fed officials expect the fed funds rate to rise or fall over the next few years. Powell said he expects the federal funds rate to reach 3.4% by the end of this year – before Wednesday’s meeting it was in a range of 2.25% to 2 .5%.

Another important consideration, Heck said, will be what Fed officials say about the central bank’s holdings of mortgage-backed securities. Earlier in the year, the Fed announced that it would reduce these holdings by about $35 billion per month, starting this month. If it decided to reduce its holdings even further, it would reduce the demand for mortgage-backed securities, which, by the internal logic of credit markets, would lead to higher interest rates.

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Leslie M. Gill