The Federal Reserve announced today that it will keep interest rates the same for the second time since beginning its current rate hike cycle aimed at taming inflation last March. The Fed projected that rates will remain higher over the next two years than previously expected, providing some unwelcome news for investors who have been hoping for rates to come down sooner rather than later.
Since last March, the Federal reserve raised the federal funds rate 11 times in an effort to control inflation by slowing the economy, bringing it up from the near-zero levels they hovered at beginning in early 2020. The federal funds rate only technically determines the interest rate at which banks can lend to each other but heavily influences the borrowing costs across the economy. The rise in rates came as the Fed tried to tackle high inflation. The consumer price index (a key economic growth indicator) peaked at 9.1% last June but came in at a more modest 3.7% last month, still well above the Fed’s 2% long-term target. The central bank’s battle on inflation seems to be working but remains far from over.
The Federal Reserve has hinted on one more .25% interest rate hike this year peaking in the 5.50%-5.75% range before starting to lower rates. The updated projections see the Fed funds target rate coming down to 5.1% by the end of next year, and to 3.9% by the end of 2025.
According to analysts, the economic projections released today (Wednesday, September 20) indicate “the Fed is more confident that they can pull off a soft landing and that the economy can withstand higher rates for longer.
By: Matthew Graham
Fri, Mar 17 2023, 4:48 PM
There’s certainly a chicken/egg problem when it comes to interest rate news. Is it the Fed’s decisions that move rates? Or do market forces move rates, thus forcing the Fed to react?
The answer is somewhere in between. If inflation and economic growth were always positive, low, and stable, the Fed would never lift a finger, but they are compelled to act when stability is threatened.
Since March 2020, the Fed has acted quite a bit. They maintained rate-friendly policies for almost 2 years and then got precipitously unfriendly early in 2022. “Unfriendly,” in this case, refers to hiking the Fed Funds Rate and buying fewer bonds on the open market. The combined effect was one of the sharpest rate spikes in history.
Now after more than a year of unfriendliness, the Fed is finally thinking about leveling off and seeing how things play out without too many more rate hikes. They’ve already decreased the pace from 0.75% per meeting to 0.25%.
This isn’t a random decision on the part of the Fed. It comes in response to shifts in inflation data as well as other signs that their unfriendly policies are having an effect on the economy.
The latest sign is the banking drama that has been in the news this week. It began with Silicon Valley Bank last week but spiraled into a bigger problem with the closure of Signature bank over the weekend. Many people have never heard of these institutions, but they now represent the 2nd and 3rd largest bank failure in US history.
Many people have heard of Credit Suisse. While the European institution has been on shaky ground for months, markets nonetheless reacted to news that it too could get swept up in the recent drama. The stock price plummeted almost all week and other European banks moved lower in sympathy.
All of the above contributed to yet another week with an obvious “flight to safety” in the market. In not so many words, this involves selling riskier assets like stocks and buying bonds. When traders buy bonds, it pushes interest rates lower (represented by US 10yr Treasury yields in the chart below), all other things being equal.
Despite the apparent panic in financial markets, the Fed will almost certainly continue to hike rates when it meets next week. It will also almost certainly signal that additional rate hikes are possible, if not probable, and that they depend much more on the path of inflation than on a handful of mismanaged banks experiencing trouble coping with a tough rate environment.
When that happens, keep in mind that the market is less concerned with how the Fed changes rates at the current meeting and more interested in how the rate outlook evolves for the coming months. That outlook is driven by two things: the Fed’s stance on the economy and the economy itself.
By maintaining a tough stance on rates, the Fed makes it harder for the economy to experience strong growth. It also means inflation will have a harder time experiencing a resurgence. That adds up to downward pressure on rates in the longer term.
As for the current week, the drop in rates was driven not only by the flight to safety, but also the expectation that the Fed will be able to start cutting rates by the end of the year. This can be seen in the following chart with September’s Fed Funds Rate expectations falling below March.
Unfortunately for the mortgage market, a classic flight to safety tends to benefit Treasuries first and foremost, even though the 10yr Treasury is often used as a benchmark for mortgage rate movement. Mortgages definitely improved--just not as noticeably as Treasuries.
That's OK though. The most sustainable improvement in mortgage rates is the improvement that happens gradually. The housing market is already responding to the apparent ceiling in rates seen in the chart above. Ever since the highs in late 2022, housing metrics have slowly come off their lower levels, as seen in the latest construction and builder confidence data released this week.
Existing and New home sales will both be released next week for the month of February, but when it comes to market movement and the impact on rates, all eyes will be on Wednesday afternoon's Fed events.
Why events? It's not just the Fed's rate hike that happens on Wednesday. They'll also have quite a few updates to the verbiage of the policy announcement. Those words will help frame the policy path going forward. Markets will get even more clarity and insight from the updated forecasts for future rate hikes (or cuts?) submitted by each Fed member. Those forecasts will likely be at odds with market expectations and it will be interesting to see how the market reacts when confronted with that reality.
Last but not least, every Fed day concludes with a press conference from the Fed Chair. This one will be one of the most important and informative in recent memory as Powell will be forced to choose between policy goals and calming a potentially panicked market.
Mortgage rates dropped again today as the 10-Year Treasury yield hit 1.74%. The 10 Year-Treasury yield is one of the biggest contributing factors for determining long term mortgage rates.
Just to help build perspective, below is a chart that demonstrates the movement of the 10-Year Treasury yield since 1960 and since 2007. As you can see, it is now at another all-time low again.
The average 10-Year Treasury yield was:
1.90% in 2015,
2.02% in 2014,
2.10% in 2013,
1.84% in 2012 (it hit its lowest point between June and August causing mortgage rates to hit an all-time historic low during that time),
2.80% in 2011, and
3.15% in 2010.
Even though the Federal Reserve raised its Federal Funds rate in December 2015 by 0.25%, we did not see an increase in long term mortgage rates primarily due to the big picture economic considerations and global financial market turmoil. Low oil prices and volatile stock markets have been helping keep mortgage rates low. Most of the more focused economic data has been falling short to move markets upwards in general. We do not anticipate the Federal Reserve to raise the Federal Funds rate again in 2016.
It is worth mentioning that last Friday's relatively positive Employment Situation report, which is one of the most important economic reports of any given month, did not impact mortgage rates for the worse as it had been anticipated to do so if the report was positive.
The current situation in the market may be a good opportunity for home buyers to secure competitive rates for their home purchase financing as well as, homeowners who currently have loans below $625,500 (the government maximum lending limit in most counties in California) to take advantage of a 30 year fixed rate loan under 4%. Jumbo loans (above $625,500) are also at one of their lowest rates as well.
For folks who intend to pay off their loan faster, interest rates are even lower for a 15 year fixed rate product. Also, the current rates for Adjustable Rate Mortgages (5/1 and 7/1 ARMs) programs are very attractive for homeowners and homebuyers who do not have the intention of keeping their current property for long term.