Article from Barry and Dan Habib from MBS Highway – 9/20/2024

The Fed cut rates 50 basis points on September 18 to a target range of 4.75% to 5%, with the effective Fed Funds Rate at 4.875%. It’s important to remember that the Fed is not cutting mortgage rates, but rather the overnight rate that banks lend to one another. This has a direct impact on short-term rates, like credit cards, car loans, personal and business loans, and short-term treasuries, etc. And it has an indirect impact on mortgage rates.

Because of this 50 bps cut, the yield curve will steepen, meaning it will be more positive. Before it was inverted, where short-term yields were higher than long-term yields, which is not normal because you would expect to get rewarded for putting your money away for longer. As the Fed cuts rates, short-term yields will fall faster than long-term yields, causing the yield curve to steepen.

As far as mortgage rates go, it depends on the perception and environment. In the past, there have been times where rate cuts were bad for mortgage rates because they can be inflationary. This may be caused by people spending less on short-term loans and have more money to spend on other things, which can bid prices higher. Businesses can borrow more cheaply and create economic activity.

But in today’s scenario, the Fed has been so restrictive for so long, raising the Fed Funds Rate 525bp to 5.375%, until they cut 50 bps on September 18. With Core PCE inflation, their favorite measure, at 2.6%, they could cut a lot more and still be restrictive on the economy.

Additionally, the Fed said that they would not cut until they felt inflation was under control – and that is the main driver of long-term interest rates like mortgages. The reason being, a 30-year loan or long duration Note like the 10-year gives you a fixed return for a long period of time, and if inflation is on the rise, your return gets eroded because things cost more, while the return stays the same. The only answer is higher rates.

But on September 18, the Fed cutting signals that they feel inflation is under control. After all, they were hiking to control it and said they would not cut until they were confident it was heading to their 2% goal.

Through the Fed’s Summary of Economic Projections (SEP), they signaled another 50 bps of cuts this year and 100bp next year. That means economic conditions are expected to get looser. They forecast that inflation will continue to come down as they cut rates, reaching 2.2% next year, which is good for mortgage rates. Additionally, they think the unemployment rate will continue to rise this year to 4.4% – which is also good for mortgage rates. If we happen to see recession-like conditions, which is possible and something the Fed fears, mortgage rates will also fall.

Bottom line: It’s possible that during this rate cutting cycle, the first cut is the deepest- meaning the Fed will likely only cut 25bp from here, unless the Unemployment Rate rises past 4.5%. Their SEP showed that all 19 Fed members don’t see the Unemployment Rate rising past that level this year, so a rise above it would likely warrant more aggressive cuts to stave off a recession.  I also believe that mortgage rates will continue to trend lower, albeit not in a straight line.