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Investors in the bond market, which funds most home loans, have cleared mortgage rates after Federal Reserve policymakers on Wednesday signaled a possible rate cut in September, allowing them to continue their decline from 2024 highs.
Concluding a two-day meeting on Wednesday, members of the Federal Open Market Committee (FOMC) said they would keep their short-term federal funds rate target between 5.25% and 5.50%, as expected.
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But Ian Shepherdson, chief economist at Pantheon Macroeconomics, noted in an email to clients that the committee made some subtle changes to the language of its post-meeting statement explaining its rationale.
Ian Shepherdson
“Progress towards the Committee’s 2 percent inflation target has been upgraded from ‘moderate’ to ‘partial’, with inflation now described as only ‘marginally’ higher,” Shepardson wrote of the change from the June statement. “At the same time, risks to achieving the employment and inflation targets ‘continue to move towards a better balance’ and the committee is now ‘focused on risks on both sides of its dual mandate’, not just inflation risks.”
In other words, Fed policymakers acknowledge that while they are determined not to cut interest rates until they are sure inflation is under control, they are also concerned that waiting too long to ease policy could send the economy into chaos.
Data released last week showed that the personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, fell to an annualized rate of 2.51% in June – just half a percentage point above the Fed’s 2% target.
Mike Fratantoni
“The FOMC did not change the federal funds rate target, but it did change its statement to acknowledge that inflation is slowing and unemployment is rising,” said Mike Fratantoni, chief economist at the Mortgage Bankers Association. And the risks to the economy are more balanced. “While the Fed still wants inflation to slow, there is now a greater risk that maintaining overly tight monetary policy over the long term could lead to unnecessary increases in unemployment.” “
At a press conference after the meeting, Fed Chairman Powell further hinted that the central bank would be prepared to cut interest rates if it sees signs of economic weakness.
“We know that reducing policy restrictions too early or too much could lead to a reversal of the progress we have made on inflation,” Powell said. “At the same time, reducing policy restrictions too late or too little could weaken economic activity and employment.”
Powell: ‘We’re ready to respond’
“If the economy remains solid, inflation will persist,” Powell warned. “We can maintain the current target range for the federal funds rate as long as appropriate. If the labor market weakens unexpectedly or inflation declines faster than expected, we are prepared to Easy to deal with.
But CME Group’s FedWatch tool, which tracks the futures market to gauge the likelihood of future Fed action, shows investors are not only convinced the central bank will cut interest rates by at least 25 basis points in September, but also have an 18% chance of approval of a rate cut. A substantial 50 basis point interest rate cut. A basis point is one hundredth of a percentage point.
As of Wednesday, bets by investors in the futures market also showed that they believed there was a 75% chance that the Fed would cut interest rates by at least 75 basis points before the end of the year, up from 20% a month ago.
Forecasters at Pantheon Macroeconomics only expect the Fed to cut interest rates by 25 basis points in September, but would then follow up with 50 basis point cuts in November and December, Shepherdson said.
That would lower the short-term federal funds rate by 1.25 percentage points to a target range of 4% to 4.25%.
“We continue to believe that the Fed was too slow to recognize that the labor market was cooling and that high inflation was a thing of the past,” Shepherdson wrote. “With rates well above neutral, if labor market data is as we expect “If weakness continues and inflation data remains benign, the easing cycle could be much faster than the market currently anticipates.”
Fratantoni said MBA forecasters are still sticking to their call for two rate cuts this year totaling 50 basis points.
Mortgage rate barometer drops
On Wednesday, the 10-year Treasury yield was hovering around 4%. Source: Yahoo Finance.
The yield on the 10-year Treasury note, a barometer of mortgage rates, remains on track to fall again on a weekly and monthly basis following Powell’s news conference. Since hitting a 2024 high of 4.74% on April 25, rising demand for bonds from investors anticipating an economic slowdown has pushed the 10-year Treasury yield down more than half a percentage point.
After closing at 4.14% on Tuesday, the 10-year Treasury yield hit a low of 4.09% on Wednesday morning before rebounding to close at 4.11% on Wednesday. This is down 38 basis points from July 1 and down 63 basis points from the 2024 high of 4.74% on April 25.
Qualifying mortgage rates plummet
The average interest rate on a 30-year fixed-rate conforming mortgage was 6.71% on Tuesday, down 30 basis points from July 1, according to rate lock data tracked by Optimal Blue.
Since hitting a 2024 high of 7.27% on April 25, conforming mortgage rates have fallen 56 basis points, or more than half a percentage point.
Borrowers seeking jumbo mortgages that exceed Fannie Mae and Freddie Mac’s $766,550 conforming loan limit are not getting much relief, as the “spread” between jumbo and conforming loans has widened.
Borrowers took on jumbo loan lock-ins on Tuesday with an average interest rate of 7.22%, down 34 basis points from the 2024 high of 7.56% recorded on April 15.
Prior to the pandemic, interest rates on jumbo mortgages tended to be an average of 9 basis points lower than conforming loans between 2017 and 2019, according to Optimal Blue. But tightening by regional banks, the major providers of jumbo loans, has reversed spreads, with jumbo mortgage rates averaging 16 basis points higher than conforming loans in 2023 and 30 basis points higher so far this year.
With interest rate cuts from the Federal Reserve looming, investors in the bond market, which funds most qualified mortgages, are happy to accept lower yields on mortgage-backed securities (MBS) backed by qualified loans. But large lenders, which typically keep loans on their books, may see their funding costs fall more slowly.
Economists at Fannie Mae and the Mortgage Bankers Association (MBA) predict that conforming loan rates will continue to fall below six points by the end of next year.
Mortgage rates expected to fall
Source: Fannie Mae and Mortgage Bankers Association forecasts, July 2024.
“Mortgage rates are now well below 7%, and refinancing activity has picked up slightly in recent weeks,” MBA’s Fratantoni said. “We expect mortgage rates to continue moving lower throughout the remainder of the year, especially if the Fed does unveil a series of rate cuts in September.”
So far, homebuyers have been slow to respond to lower interest rates, as rising home prices and interest rates during the pandemic have driven many would-be buyers out of the market.
MBA’s weekly survey of lenders showed that seasonally adjusted home loan applications fell 2% last week from the previous week and were down 14% from a year ago. Refinancing application volume fell 7% from the previous quarter, but increased 32% year-over-year.
Eric Orenstein
“Even with a potential rate cut in September, mortgage companies will continue to face significant earnings headwinds for the foreseeable future,” Eric Orenstein, senior director at Fitch Ratings, said in a statement. With interest rates on most outstanding mortgages still below 5% and record house prices driving down affordability, a return to higher origination volumes may be a long way off.”
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