If you’re looking to buy a home, you’ve probably been paying close attention to mortgage rates. Over the last couple of years, they hit record lows, rose dramatically, and are now dropping back down a bit. Ever wonder why?
The answer is complicated because there’s a lot that can influence mortgage rates. Here are just a few of the most impactful factors at play.
Inflation and the Federal Reserve
The Federal Reserve (Fed) doesn’t directly determine mortgage rates. But the Fed does move the Federal Funds Rate up or down in response to what’s happening with inflation, the economy, employment rates, and more. What is the Federal Funds Rate? It is defined as the target interest rate range set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. And as the Federal Funds Rate moves up or down, mortgage rates tend to respond in the same way. Business Insider explains:
“The Federal Reserve slows inflation by raising the federal funds rate, which can indirectly impact mortgages. High inflation and investor expectations of more Fed rate hikes can push mortgage rates up. If investors believe the Fed may cut rates and inflation is decelerating, mortgage rates will typically trend down.”
Beginning early 2022, the Fed began raising the Federal Funds Rate to try to fight inflation and, as that happened, mortgage rates jumped up, too. Fortunately, the expert outlook for inflation and mortgage rates is that both should become more favorable over the course of 2024. As Danielle Hale, Chief Economist at Realtor.com, says:
“[M]ortgage rates will continue to ease in 2024 as inflation improves . . .”
There’s even talk the Fed may actually cut the Fed Funds Rate this year because inflation is cooling, even though it’s not yet back to their ideal target. That’s significant because, historically, there’s been a connection between inflation and mortgage rates (see graph below):
This graph shows a pretty reliable relationship between inflation and mortgage rates. Looking at the left side of the graph, each time inflation moves significantly (shown in blue), mortgage rates follow suit shortly after (shown in green).
The circled portion of the graph points out the most recent spike in inflation, with mortgage rates following closely behind. As inflation has moderated a bit in the last quarter of 2023, mortgage rates have started to make a similar move (not reflected in the graph yet).
That means, if history is any guide, mortgage rates should follow inflation and continue to head back down. It’s impossible to accurately predict where mortgage rates will go for sure, but moderating inflation means mortgage rates going down some in 2024 would fit a well-established trend.
The 10-Year Treasury Yield
Additionally, mortgage companies look at the 10-Year Treasury Yield to decide how much interest to charge on home loans. If the yield goes up, mortgage rates usually go up, too. The opposite is also true. According to Investopedia:
“One frequently used government bond benchmark to which mortgage lenders often peg their interest rates is the 10-year Treasury bond yield.”
Historically, the spread between the 10-Year Treasury Yield and the 30-year fixed mortgage rate has been fairly consistent, but that’s not the case recently. That means, there’s room for mortgage rates to come down. So, keeping an eye on which way the treasury yield is trending can give experts an idea of where mortgage rates may head next. Here’s a graph showing those two metrics since Freddie Mac started keeping mortgage rate records in 1972:
As the graph shows, historically, the average spread between the two over the last 50 years was 1.72 percentage points (also commonly referred to as 172 basis points). If you look at the trend line you can see when the Treasury Yield trends up, mortgage rates will usually respond. And, when the Yield drops, mortgage rates tend to follow. While they typically move in sync like this, the gap between the two has remained about 1.72 percentage points for quite some time. But, what’s crucial to notice is that spread is widening far beyond the norm lately (see graph below):
If you’re asking yourself: what’s pushing the spread beyond its typical average? It’s primarily because of uncertainty in the financial markets. Factors such as inflation, other economic drivers, and the policy and decisions from the Federal Reserve (The Fed) are all influencing mortgage rates and a widening spread.
Why Does This Matter for You?
This may feel overly technical and granular, but here’s why homebuyers like you should understand the spread. It means, based on the normal historical gap between the two, while there has been some improvement in mortgage rates, there’s room for more improvement in the coming months.
And, experts think that’s what lies ahead as long as inflation continues to cool. As Odeta Kushi, Deputy Chief Economist at First American, explains:
“It’s reasonable to assume that the spread and, therefore, mortgage rates will retreat in the second half of the year if the Fed takes its foot off the monetary tightening pedal . . . However, it’s unlikely that the spread will return to its historical average of 170 basis points, as some risks are here to stay.”
Similarly, an article from Forbes said:
“Though housing market watchers expect mortgage rates to remain elevated amid ongoing economic uncertainty and the Federal Reserve’s rate-hiking war on inflation, they believe rates peaked last fall (2022) and will decline—to some degree—later this year, barring any unforeseen surprises.”
This did occur to some degree, as predicted, late in 2023. Yet many experts continue to believe there is room for additional improvement in mortgage rates. Whether that occurs or not will be impacted by what stance the Fed takes in coming months regarding their analysis of the inflation numbers.
Bottom Line
With the Fed meeting today (January 31), experts in the industry will be keeping a close watch to see what they decide and what impact it will have on the economy. To navigate any mortgage rate changes and their impact on your moving plans, it’s best to have a team of professionals on your side. Questions on what this means for you? Give us a call, we’d love to chat!
Real Estate | Your@HomeTeam 