Fed Cuts Rates in Much Anticipated Move as Data Softens

The long-anticipated interest rate cut has finally happened.  You might be surprised with the limited reaction by the market to the .50% cut in interest rates.  The market has been anticipating the interest rate cut for months.  The expectation that the Federal Reserve would cut short-term interest rates was one of the factors that lead to the 1.00% drop in the 30-year fixed rate mortgage interest rate over the last few months.  Going forward as the Federal Reserve continues to cut interest rates the interest rate on 30-year fixed rate mortgage may not move substantially.  The mortgage market is finally returning to normal levels.  You need to go back prior to the housing crisis to see what normal mortgage interest rates look like.  The Freddie Mac Research group generated the following graphs.  The first graph shows the historical Primary Mortgage Market interest rate. 

The graph shows that the current mortgage interest rate has returned to the interest rates offered during the first decade of the century prior to the housing market.  You can see from the graph the dip in interest rates that occurred starting in 2008 with the housing crisis.  The housing crisis was a pivotal time for both fiscal and monetary policy.  The housing crisis ushered in a time of zero interest rates from the Federal Reserve and massive deficit spending to stimulate the economy to keep the economy from tipping into a depression.  From the housing crisis until 2022 mortgage interest rates were kept artificially low because the Federal Reserve not only kept short term interest rates at zero.  The Federal Reserve also bought large amounts of long-term Treasuries and Mortgage-Backed Securities.  Since 2022 the Federal Reserve has raised short term interest rates and sharply curtailed their purchase of US Treasuries and Mortgage-Backed Securities. 

The Federal Government is still running very large deficit that will be stimulating the economy and could limit the size of future Federal Reserve interest rate cuts.  The next graph from the Freddie Mac Research group shows the relationship between interest rate mortgages, 10-year treasury yields, and Fed Funds.  You can see that mortgage interest rates and the 10-year treasury yield are very closely correlated.  The Fed Funds rate is not closely correlated to mortgage interest rates.  As you look at these graphs, keep in mind that the GSE have raised guarantee fees by over 40 basis points which will explain .40% of the widening between the spread between the Primary Mortgage Market interest rate and the yield on the 10-year treasury.  The Federal Reserve can have a great influence on short-term interest rates for credit cards, auto loans, and interest rates banks pay on deposits.  Mortgage interest rates will be affected more by the expectation for future inflation.  Federal Reserve policy decisions could have an indirect effect on the mortgage market by signaling their level of concern about future inflation.

This guest post was authored by Ted Tozer, Non-Resident Fellow, Housing Finance Policy Center, Former President and CEO of Ginnie Mae & AISLE Cross-Section Leader.