Do Higher Fed Rates Mean Higher Mortgage Rates?

The Fed has thrown down the gauntlet. Its Federal Open Market Committee (FOMC) has decided that now is the time to challenge the soaring inflation levels seen in recent months, levels much higher than the 2% or so the Committee has been willing to accept.

In fact, Inflation at year-end is remarkably high. The Bureau of Labor Statistics just said “the all items index rose 6.8% for the 12 months ending November, the largest 12-month increase since the period ending June 1982.”

“No doubt many will cheer the Fed’s policy shift. It should help banks generate higher profits,” said Rick Sharga, Executive Vice President with RealtyTrac, “Savers will benefit. That said, borrowers – including mortgage borrowers – may face higher rates and that could slow home price increases and perhaps even cause values in some markets to fall.”

What the Fed decided

The Fed has been buying debt at the rate of $40 billion a month in mortgage-backed securities (MBS) and $80 billion a month in Treasuries in an effort to hold down mortgage rates. Starting in December, it began reducing (tapering) purchases by $10 billion and $20 billion per month, respectively. The new Fed announcement accelerates the reduction pace to $20 billion per month for MBS purchases and $40 billion per month for Treasuries, starting in January. In effect, the Fed will end the special buying process around March instead of this summer.

“The Fed,” said The New York Times, “has made clear it wants to end its bond-buying program before it raises rates, which would cool off demand by making it more expensive to borrow for a home, a car or expanding a business.

“That would in turn weigh on growth and, eventually, price gains,” the Times continued. “The Fed’s new economic projections suggested rates, which have been at rock-bottom since March 2020, might rise to 2.1% by the end of 2024.”

While the Fed has explained what it wants to do, that may be very different from what it actually does. For instance, the federal funds rate at this time is between 0.00% and 0.25%. A 2.1% rate is possible, but 2024 is a long way off.

Predictions and pandemics

Why did the Fed change its policies?

The FOMC provided several reasons for its new policies, reasons which are surely debatable.

For instance, it says that “with progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen.”

But policy support for the Covid-19 vaccine is hardly universal. State governments in several states, including Florida and Texas, plainly do not back federal vaccine policies. The courts have divided over mandatory vaccination programs, with some ruling for, some against. No less important, a large portion of the population is not rushing out for the shots. According to Axios, as of mid-December 73 million people who qualify remain unvaccinated.

The emergence of the Omicron variant toward year-end complicates Fed planning. We don’t know if Omicron is generally mild or dangerous. And we surely cannot say if there will be new variants in circulation in 2022 or how they might impact the public.

What we do know is that more people died from Covid-19 in 2021 than in 2020. The pandemic is not over and if cases materially increase at the same time the Fed is raising interest rates, the result could be a significant economic slow-down.

Jobs & mortgage rates

The FOMC says that “job gains have been solid in recent months, and the unemployment rate has declined substantially.” Really? We don’t have enough truck drivers to clear-out backed-up West Coast ports. The construction industry had 410,000 job openings in October. The workforce included 148.6 million people in November – down 3.9 million from February 2020.

What about mortgage rates?

Whatever the Fed decides impacts the marketplace and cannot be ignored. That said, the marketplace may not react the way the Fed expects.

Shouldn’t mortgage rates rise if bank rates go up? Sounds logical, but the specifics are not so clear.

First, the expectation of a Fed rate hike has been built into current rates. As Mortgage News Daily reported the day the Fed announced its new policy, “mortgage rates were fairly flat heading into today’s important Fed announcement. Despite arguably receiving bad news, they didn’t move too much higher by the end of the day.”

Second, the Fed has limited sway over nonbanks, the entities that originate the majority of mortgage loans. The Wall Street Journal reported this summer that nonbanks “issued 68.1% of all mortgages originated in 2020, up from 58.9% in 2019, according to industry research firm Inside Mortgage Finance. That is their highest market share on record and their biggest yearly gain since 2014.”

Third, as big as the Fed is, it does not control the worldwide supply of capital. There’s too much cash and too little demand right now. In September, the Financial Times reported that there was almost $15 trillion invested worldwide with negative yields. Much of that money can potentially come to the US, so much that it might push down mortgage rates.

Lastly, as bad as the monthly inflation rates are today, we may see far-lower rates going forward. Supply chain issues will likely straighten out, creating product surpluses, discounts, and fewer re-orders for next year. The Fed gets this. It’s “prepared to adjust” its policies, which may mean there will not be three interest rate increases in 2022.