So many Buyer believe that when the Feds lower interest rates that the mortgage rates will lower and this is not true. If you read my last Blog post you will have read (it is available on the website) what the Fed is and how is was formed and how it works-a truly must read!
My referral Partner Tom Bonetto (who does my client’s lending for 1-4 units and is truly amazing) has put together the article below. It is worth the read!
As we have seen over the last few days, mortgage rates and bonds have actually worsened since the Federal Reserve cut their Federal Funds rate on September 17th.
Markets, including longer-term treasuries and mortgage rates, are forward-looking and often price in a Fed rate cut in advance of the actual Fed cut, once it has been clearly telegraphed.
I’ve read many articles recently that fall into the trap of disregarding the forward-looking nature of the market by measuring the effect of a Fed rate cut on longer-term rates and mortgage rates from the date of the cut.
More importantly, there are coincident economic reports that can greatly influence the move in interest rates subsequent to the cut.
The September 17th Cut
Let’s look at a few examples. Most recently, the Fed cut rates on September 17 and the 10-year Treasury touched at 3.99% that day. Yields have risen since then to 4.17% (as of today), and a large contributing factor was the sudden drop in initial jobless claims on September 18 – the morning after the Fed cut rates.
The Fed’s rational for cutting rates, even though Core Personal Consumption Expenditures (PCE) is above their target, was because they were concerned about weakness in the labor market.
But initial claims showed a drop from 264K in the previous read to 231K. This significant drop, to some degree, is contrary to a weakening labor market, and didn’t support the Fed’s reasoning for cutting rates.
Prior to the Cut
Now let’s look at what happened before the most recent Fed cut on September 17. During his Jackson Hole speech on August 22, Chair Jerome Powell clearly telegraphed that a rate cut was coming. This was when the bond market started to react.
The day of the Jackson Hole speech by Powell, the 10-year Treasury was at 4.32%. By the time of the actual cut on September 17, the 10-year Treasury had dropped by over 25bp.
Additionally, mortgage rates dropped even more, thanks to a narrowing mortgage spread. So, looking at the change in rates after the Fed actually cuts ignores the market’s anticipation of the cut and leads to false narratives.
Recent History
There is a lot of historical precedent for this as well. Look no further than the Fed’s 50bp rate cut on September 18, 2024. The chart below paints a very clear picture.
In the two to three weeks prior to the actual cut, the 10-year Treasury made a significant drop in yield, and mortgage rates declined by a whopping 5/8%. Again, markets are forward-looking.
Subsequent to the Fed cut, mortgage rates and Treasuries remained stable until October 4, when the September 2024 jobs report was released. There was a huge upside surprise in job creations totaling 254K, which sent the bond market into a selloff.
We now know, from the QCEW, that it is likely that less than half of those jobs were actually created.
This is why we need to dig more deeply, and not only contemplate the market’s anticipation, but consider what factors caused interest rates to move subsequent to the Fed rate cut. Had the jobs number been less than market expectations, it’s highly likely that interest rates would have declined.
And the same story applied to the next rate cut on November 7, 2024. The chart below shows that mortgage rates were declining until another upside surprise in the job numbers released in early December caused them to bump higher. And this happened yet again after the December 18, 2024 cut.
Long Term History
Now, let’s gain a more historical perspective. As you can see over the long run, there is a reasonably good correlation between the direction of the Fed Funds Rate and mortgage.
We also need to look at what the Fed is leaning towards in their upcoming meetings The “Dot Plot” system is the Fed’s way of giving the public a snapshot of how its policymakers see the future path of interest rates, but it’s always subject to change as the economy evolves.
I don’t recall a more divided Fed with such wide disparities in opinion. Future Fed rate cuts this year hang tenuously on continued labor weakness. Therefore, strength in the labor market would likely take the expected two additional rate cuts through the end of 2025 off the table.
This puts enormous focus on the outcome of the September jobs report, which is set to be released on October 3. This will ultimately decide the direction of Fed cuts at their upcoming meetings.
All that said, another factor which must be contemplated is the market’s interpretation of whether a Fed rate cut could be too stimulative to the economy, bringing on an increase in inflationary pressures.
In Conclusion
As shown above, there are many factors that go into the reaction mortgage rates have to Fed rate cuts.
So, to simply state that mortgage rates and long-term Treasury yields rise when the Fed cuts rates is not only myopic, but a fool’s game, as it fails the deep thinking required to correctly analyze all the above considered.
Please feel free to give Tom a call with questions (480) 788-2658
