The Fed Is About To Raise Interest Rates Again – So Why Are Mortgage Rates Falling?
The Federal Reserve is expected to raise interest rates by half a percentage point on December 14, 2022, to a range of 4.25 to 4.5%, the seventh increase this year. So far in 2022, the Fed has raised its benchmark short-term interest rate, which affects most other borrowing costs in the economy, by 3.75 percentage points from a low of around zero in March.
But even as the US central bank continues to raise interest rates – and plans to do so in 2023 – homebuyers are beginning to notice a pleasant surprise: mortgage rates are falling.
What’s going on?
We asked Brian Blank, a professor of finance who has researched mortgage rates and bank loans, to explain the paradox of lower mortgage costs at a time when prime rates are higher.
What happens to mortgage rates?
After skyrocketing for much of 2022, mortgage and other long-term rates are starting to fall.
The 30-year average mortgage rate has fallen 0.75 percentage points in the past month or so, after hitting a 20-year high of 7.08% in early November. Rates reached 6.33% on December 8, the lowest level since September. This happened during the same period that the Fed raised its benchmark interest rate by 1.5 percentage points.
Another major rate drop was the yield on the 10-year Treasury note, which fell by a similar amount, to 3.5%.
Why are mortgage rates falling if the Fed is still rising?
The short and somewhat boring technical answer is that bond markets have been anticipating this rate hike for several months. Since market factors largely dictate borrowing costs, the increase in home loan rates has already been internalized.
While mortgage rates are rising due to the rapid pace of the Fed’s hikes, they are actually closely related to the interest rate on Treasury securities, specifically the yield on the 10-year Treasury note. This safety began anticipating a Fed rate hike a year ago and has risen from less than 1.5% in December 2021 to more than 3.25% by June.
Now, with indications that inflation has already peaked and amid growing fears of a slowing economy, these long-term rates are dropping in anticipation of lower future rate hikes by the Fed than expected only a short time ago. In fact, mortgage and other long-term rates may continue to fall over the coming months — assuming the Fed manages to get inflation under control so it can lower its benchmark interest rate again.
Why do mortgage rates track 10-year Treasury yields?
Although 30-year mortgages can be held for three decades, most people sell or refinance their home within a decade, which means that the investor receiving the mortgage payment is actually investing in a 10-year bond.
As a result, the average interest rate on a 30-year mortgage is typically 1 to 2 percentage points higher than the yield on a 10-year Treasury note.
However, when the economy has more uncertainty than usual, as it did earlier this year, that difference can be as high as 3 percentage points. This uncertainty could be a result of a possible economic downturn, the possibility of the Fed raising interest rates more than expected, inflation, changes to the Fed’s balance sheet or all of the above – as happened in 2022.
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