What Fed Rate Cuts Really Mean

Since the Fed cut rates 50 basis points on September 18, we've seen 30-year fixed mortgage rates rise meaningfully. You may be wondering how this can be.

The Fed is reducing the Fed Funds Rate, which is not mortgage rates or even a long-term rate. The Fed Funds Rate is a very short-term rate, literally a rate that’s only good overnight. Banks use this as the rate that they lend money to one another, but it is the building block for all interest rates.

When the Fed changes the Fed Funds Rate, it almost immediately impacts things like money market accounts, credit cards, car loans, home equity lines of credit, etc. etc.

But long-term rates, like mortgage rates, are impacted more indirectly. An example of this happens as the Fed cuts rates and investors’ returns on money market funds decrease. If it’s anticipated that the Fed will continue to lower rates, which in turn will continue to reduce the return on money markets, investors may want to preserve their returns by selling their money markets and buying longer duration bonds like 10-year Treasuries. As more 10-year Treasuries are purchased, their price tends to improve, which in turn lowers the yield. Mortgage rates typically follow the direction of 10-year Treasuries.

Recently, in anticipation of a well-telegraphed rate cut, the 10-year Treasury and mortgage rates had declined significantly. Therefore, the financial markets had already priced in the cut by buying Treasuries in advance of the Fed announcement.

And after the Fed’s cut, a surprisingly strong job report and more stubborn inflation data were released. This has created a spike higher in mortgage rates.

It’s quite possible that the Fed will continue to reduce rates, and eventually see that filter into mortgage rates.

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By Dan Habib