Why a Fed Rate Hike Could Bring Mortgage Rates Down
Much of the mortgage and real estate industry was very nervous about a potential hike in the Fed Funds Rate (the overnight rate banks charge each other to borrow) last week when the Fed met.
Everyone was thinking…”No way can we handle even higher rates…”
And while markets still leaned toward a hold, the odds of a hike had spiked to their highest levels of this entire cycle in the days before the meeting – and a surprising number of prominent analysts were openly calling for a hike to fight inflation.
The Fed ended up holding steady – with no hike. Three Fed officials actually dissented in favor of a hike, but the majority held.
So mortgage rates fell in relief, right?
Wrong. Long-term rates SPIKED after the meeting – with the 30-year Treasury yield hitting its highest level since 2007, and mortgage rates climbing right along with it.
Why? Because the bond market read the “no hike” decision as the Fed going soft on inflation. Wall Street analysts literally called it an “inflation credibility shock.”
And that brings us to the counterintuitive point of this blog: if the Fed HAD increased the Fed Funds Rate, mortgage rates very likely would have gone DOWN.
The bond market, which controls long-term interest rates, responds to two things: growth expectations and inflation expectations.
A Fed rate hike would have been perceived as the Fed getting serious about fighting inflation.
In addition, a hike would have been perceived as slowing growth.
And both of those factors tend to bring down long-term (mortgage) rates.
Remember 2024: When the Fed CUT the Fed Funds Rate by 1% that fall, mortgage rates ROSE about 1% in response – because the bond market perceived the cuts as fanning inflation.
So – this is just one more reminder that the Fed does not control long-term (mortgage) rates. And that long-term rates often move in the OPPOSITE direction of the short-term Fed Funds Rate.
This is NOT to say that long-term rates never move in the same direction as the Fed Funds Rate. They do – in two situations:
- When the bond market thinks the Fed isn’t doing enough. 2022 was a great example: mortgage rates rose right alongside the Fed’s hikes, as the bond market knew inflation was a major problem and that many more increases were coming.
- When the Fed and the bond market are reacting to the same shock. At the start of COVID, long-term rates fell in conjunction with the Fed’s emergency cuts – not because of the cuts themselves, but because everyone was worried about the same thing: an economy grinding to a standstill.
One last thing to watch: betting markets now put the odds of a September rate hike at over 50%.
And if the Fed actually delivers that hike – don’t be surprised if mortgage rates FALL in response.
