Fed Forecast To Bring Down Rates Pushes Mortgage Rates Lower
The recent dovish pivot by the Federal Reserve, along with projections of up to three rate cuts next year, brought a sigh of relief to the markets. Equities, bonds, gold, and oil, all rallied in response. This shift by the Fed signaled a so-called “soft-landing” narrative. Inflation data has been pointing toward lower inflation as the economy continues to move forward with weak manufacturing data, but a strong service sector.
Mortgage rates also saw a significant drop, with 30-year mortgages now below 6.50%, and adjustable-rate mortgages anticipated to dip below 6%. This is a remarkable change from just a few weeks ago when mortgage products were touching 8%. Let’s delve into the reasons behind this sudden change of heart by the Fed and the markets.
Inflation Trends
Consumer and producer inflation data have been showing positive trends for quite some time. With inflation on the decline, the Fed Funds Rate, currently at 5.37%, stands well above the inflation rate (CPI) of 3.1%. This significant spread is viewed as restrictive, and now the Fed must consider if keeping rates higher for an extended period might do more harm than good. Additionally, signs of a slowing economy are emerging, which further supports the case for lowering interest rates.
Inverted Yield Curve
The yield curve has been inverted for an extended period, and the Fed would like to see it normalize. This normalization would benefit lenders who borrow short and lend long. When long-term interest rates are lower than short-term interest rates, it becomes challenging for lenders to generate profits due to the negative spread. A robust economy requires lenders willing to extend credit. Moreover, the massive US debt and the costs associated with servicing that debt become unsustainable at higher interest rates.
Quantitative Tightening (QT)
The ongoing QT (Quantitative Tightening) may provide the Fed with some flexibility to lower short-term interest rates and allow bonds to run off their balance sheet. Over the past decade, global central banks’ money printing and bond buying have led to enduring issues, as the cost of money became distorted. By lowering the Fed Funds Rate while continuing QT, the Fed remains somewhat restrictive but with a bit less tightening.
Nonetheless, we still anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. When you add a term premium of 1% to 1.5%, that’s where the 10-year Treasury should find its equilibrium.
10 Year Treasury & Employment
As previously stated, we continue to anticipate a 10-year Treasury yield north of 4% and encourage clients to pursue financing at these current rates. We believe that the journey from 3% to 2% inflation will be challenging, and the so-called neutral rate of interest will likely settle above 3%. Employment remains tight and wages appear to be sticky (and possibly rising again) which will continue to be monitored by the Fed. This could inhibit interest rates from going much lower than current levels.
For the moment, we will take the late-year gift from the Fed of the prospect of lower interest rates which is leading to a big pickup in borrower inquiries.
