Why are mortgage rates falling amid Federal Reserve rate hikes?

Mortgage rates Federal Reserve rate hike

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A For Sale sign is posted in front of a single family home on October 27, 2022 in Hollywood, Florida.

The Federal Reserve Interest rate hikes are to be expected by half a percentage point on December 14, 2022 to a range of 4.25 to 4.5%, what that would be seventh increase this year. So far in 2022, the Fed has raised its short-term interest rate, which drives most other borrowing costs in the economy, by 3.75 percentage points from a low of around zero as recently as March.

But even as the Federal Reserve continues to hike rates – and plans to continue to do so in 2023 – homebuyers are beginning to notice a pleasant surprise: Mortgage rates have fallen.

What’s happening?

We asked Brian Blanka finance professor who has researched mortgage rates and bank loansto explain the paradox of falling mortgage costs as interest rates rise.


What happens to mortgage interest rates?

After spiking for much of 2022, mortgage rates and other long-term interest rates are beginning to fall.

The average interest rate on a 30-year mortgage fell by 0.75 percentage points in the last month or so after hitting a 20-year high of 7.08% in early November. Interest rates hit 6.33% on December 8th, the lowest level since September. This happened during the same period when the Fed raised interest rates by 1.5 percentage points.

Another fall in interest rates is the 10-year government bond yield has decreased by a similar amountto 3.5%.


Why are mortgage rates falling when the Fed is still on the rise?

The short and rather boring technical answer is that bond markets have been expecting this rate hike for many months. And with market factors largely dictating borrowing costs, the increase has already been absorbed in home loan rates.

Mortgage rates, while rising because of the Federal Reserve’s rapid pace of rate hikes, are actually more closely linked to it Interest rate on government bonds, especially the yield on the 10-year government bond. This security began anticipating Fed rate hikes a year ago rose from less than 1.5% in December 2021 to over 3.25% by June.

And now, with signs that inflation has already peaked and amid mounting concerns about a slowing economy, these longer-term rates are falling in anticipation of fewer future Fed rate hikes than recently expected. In fact, mortgage rates and other long-term interest rates could fall further in the coming months – assuming the Fed manages to get inflation under control so that it can cut interest rates again.


Why do mortgage rates follow the 10-year Treasury yield?

Although 30-year mortgages can be held for three decades, Most people sell their home or refinance within a decademeaning that the investor receiving the mortgage payments is effectively investing in a 10-year bond.

As a result, the average interest rate on 30-year fixed-rate mortgages is normal 1 to 2 percentage points higher than the yield on a 10-year government bond.

However, when the economy faces more uncertainty than usual, as it did earlier this year, This spread can be up to 3 percentage points. This uncertainty may be the result of a potential economic situation downturnthe possibility of the Fed raising rates more than expected, inflation, Fed balance sheet changes or all of the above – as happened in 2022.


Why Are Mortgage Rates Higher Than Treasury Yields?

Since the US Treasury Department is more likely to repay investors than almost any individual homeowner, Investors demand a higher interest rate because of the extra risk they are taking.

Even when individuals go to banks for loans, Banks often sell these loans to investorswho then receive the money that individuals pay back for the loan.

With individuals defaulting on mortgage payments more often than the U.S. government defaults on Treasuries, investors require a higher return acquire the rights to receive the payments under those mortgages.


If mortgage rates fall, does the Fed need to raise rates more to control inflation?

Falling mortgage rates preceded a rise in the home purchase index, which is a measure of the current market conditions to buy houses. This suggests the The housing market could finally pick up steam after slowdown all year.

The Fed is trying to slow down the economy activity to bring down inflation, this housing prices could cause rise again, forcing the Fed to raise interest rates more than planned.

However, I believe the effective federal funds rate, the market rate directly affected by the Fed’s target range, already is sufficiently restrictive to slow the housing market and restore more normal economic conditions in 2023. Additionally, the fall in mortgage rates is still fairly small — they remain more than double what they were a year ago — so the fall likely won’t have much of an impact on its own.

What the Fed itself thinks of this challenge – and where it is projects to take interest Prices next year – is what I and many others economists and investors will be watching closely as they meet for the last time in 2022. It should tell us what’s in store for us in 2023, so stay tuned.The conversation

By D. Brian BlankAssistant Professor of Finance, Mississippi State University

This article is republished by The conversation under a Creative Commons license. read this original article.

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