What a Fed Rate Cut Means for Mortgage Rates

When the Federal Reserve announces a rate cut—especially a 50-basis point (or half point) cut—many people immediately assume mortgage rates will follow suit and fall significantly.

The reality is that they normally get worse.

This may seem counter-intuitive, but when the Federal Reserve drops rates, it’s rather inflationary which is the enemy of low mortgage rates. Mortgage Rates actually do NOT like rate cuts. (more on that later). The connection between the Federal Reserve rate cuts and mortgage rates is not as it seems.

If you’ve been watching closely, you may have noticed that mortgage rates stayed flat or even ticked up slightly after the recent half point rate cut. Why is that?

Mortgage rates follow inflation. If inflation is down, mortgage rates are down, conversely, if inflation is high, mortgage rates are high. Beyond that, the projected FUTURE of inflation is what really drives mortgage rates and that’s that I’d like to dive deeper into. Specifically, how the Fed’s actions influence mortgage rates, the long-term impact on inflation, and why now is the best time to act if you’re looking to buy or refinance.

Fed Rate Cuts are Not a Direct Influence on Mortgage Rates

My client texts me. “Hey Rick, I saw the Fed just cut interest rates by .5%. Can I get a lower rate?” I knew this was the first of many texts, emails and phone calls I would receive from those wanting that lower rate!

I responded, “Thank you for your text! What happened today with the Fed dropping rates half a percentage point was a good sign for mortgage rates, but we actually saw rates go up today. I know… crazy right? Rates got worse shortly after the Fed announcement. I do see a decline in rates in the coming months because of expected future cuts, but what happened today had already been priced into the market.”

It’s crucial to understand that the Fed’s decisions to cut interest rates are aimed at helping the consumer. These ‘rate cuts’ influence short-term rates, such as those for credit cards, auto loans, and business loans. Mortgage rates, however, are linked to inflation and are not directly influenced by the Federal Reserve. In fact, rate cuts are bad for mortgage rates because they are inflationary.

Inflation is the enemy of mortgage rates. Inflation low, rates good. Inflation high, rates bad.

What we are seeing now is the Fed playing catch up and dropping rates to avoid a prolonged recession (more on that later). When we talk about mortgage interest rates coming down, it is more based on the overall economic outlook, including the market’s expectations for inflation. This is important because the mortgage markets are forward-looking and reactive at the same time.

When inflation is coming down (or has come down), you can expect mortgage rates to follow suit. The converse is true as well. And when the Fed makes a rate cut (or hike), it’s usually responding to broader economic conditions that the mortgage market has already factored into current rates.

In the case of the recent 50 basis point cut, the markets had already priced it in well before the announcement. So, rather than seeing mortgage rates plummet immediately after the cut, rates stayed flat and even worsened slightly.

The Fed’s Role in Managing Economic Stability

The Federal Reserve’s primary objective is to maintain economic stability. It’s no secret that the economy has suffered, and we are seeing the reports of a flailing economy. However, with lower rates, businesses have access to cheaper capital which they can turn and use to hire (or keep) more employees, expand their business, or even keep up with the need to increase wages. This affects employment, a very key inflation metric.

The other side of this coin are prices. Prices for food (don’t ask me how much I spent at Publix last month), gas and other consumables has risen through the roof. When inflation rises above their target, typically around 2%, the Fed looks to raise rates to cool down the economy. And when economic growth slows and the risk of recession looms, the Fed lowers rates to stimulate the economy, i.e. borrowing, investment, and spending.

Right now, the Fed is working to prevent what’s known as a “hard landing”. By cutting rates, they will ease financial conditions and hopefully avoid an extended recession.

However, there’s a tradeoff. While cutting rates can help in the short term, it can also fuel inflation over the long run. By making borrowing cheaper, the Fed encourages spending, which can increase demand and ultimately lead to higher prices if supply doesn’t keep up. That’s why, while rate cuts may provide immediate relief, they create inflationary pressures.

It’s a weird balancing act. The Fed had raised rates to cool off the economy and drive down inflation that had gotten out of control. Now, they cut rates when they see an economy that needs a bit of a kick start.

What’s Next from the Central Bank?

The Federal Reserve has already signaled that we may see another 50 basis points in rate cuts before the end of the year, with an additional 100 basis points of cuts by the end of 2025. However, the pace of these cuts could vary depending on a number of factors, including the outcome of the November elections.

The Fed’s overall goal is to bring inflation down to its long-term target of around 2%. Until we see evidence that inflation is consistently cooling to that level, it’s likely that rates will continue to drop gradually.

Why Mortgage Rates Didn’t Move After the Cut

You might be wondering: If the Fed is cutting rates, why aren’t mortgage rates following suit? The answer lies in the forward-looking nature of mortgage markets.

Mortgage lenders base their rates on what they believe will happen in the future, not just today. This means the market often “prices in” expected rate cuts (or hikes) well before they actually happen.

Since the recent 50 basis point cut was widely expected, mortgage rates had already adjusted in anticipation of the Fed’s move. Had we seen only 25, mortgage rates would have given up much of the very sharp improvement we have seen the last 30 days.

Looking ahead, I expect mortgage rates to continue falling until there is clear evidence that inflation is under control and that the Fed’s 2% target is within reach. However, predicting the exact movement of mortgage rates is difficult, especially with external factors like elections and global economic conditions coming into play. After November, anything could happen.

Should You Wait or Act Now?

Given the uncertainty surrounding future rate movements, you might wonder whether it’s worth waiting to lock in a mortgage rate. My advice? If you’re thinking about buying or refinancing, now is the best time to act.

With the Fed expected to continue cutting rates and the mortgage market already pricing in these moves, mortgage rates may not fall much further. In fact, after the November elections, depending on who wins, rates could rise again.

Government spending, corporate tax initiatives, personal and corporate tax increases… all these tell a big story to the Fed as to what pressures we will see. We’ve already seen what the trillions in government spending did to consumer prices which forced the Fed to take action. The results of which took mortgage rates from 3% in October 2021 to over 8% by October of 2023.

In short, the window of opportunity could be closing soon. Waiting to see how things play out may result in missing today’s low mortgage rates and lower home prices.

The Bottom Line

While the Federal Reserve’s rate cuts are important, they don’t automatically translate to lower mortgage rates. The mortgage market is forward-looking, pricing in changes well before they happen. If you’re in the market for a home or considering refinancing, now may be the best time to lock in a favorable rate before market conditions become even more uncertain.

If you’d like to see current mortgage rates, you can see those live HERE.

Keep an eye on future rate cuts and remember: the Fed’s actions are part of a larger effort to stabilize the economy, but mortgage rates are influenced by a variety of factors, some of which are impossible to predict. Don’t wait until it’s too late! Act now to take advantage of today’s rates before the landscape shifts.

For questions, don’t hesitate to leave a comment or email Rick at: rick@loanwithrick.com