At its latest meeting, the Federal Open Market Committee—the arm of the Federal Reserve responsible for setting interest rates—voted to hold rates steady for the fifth consecutive meeting.
While the decision was widely expected, signs of disagreement are beginning to emerge among Fed officials. Unlike the June meeting, which resulted in a unanimous vote to leave rates unchanged, three officials at the July 29 meeting voted to raise rates by a quarter of a percentage point, while nine voted to keep them steady.
The overnight, or benchmark, lending rate remains at 3.5% to 3.75%, following six rate cuts over the past two years.
The sticking point for the committee continues to be inflation. Calls for another rate hike could grow louder if inflation remains above the Fed’s 2% target and the labor market continues to show strength.
For the housing market, the takeaway is continued volatility, particularly if inflationary pressures intensify.
While the federal funds rate has little direct effect on mortgage rates, expectations for future Fed policy and persistent inflation can have a major influence on borrowing costs. Simply cutting the federal funds rate does not guarantee lower mortgage rates.
The federal funds rate is essentially an overnight lending rate—the rate financial institutions charge one another to borrow money. Fixed rates on long-term mortgages are not directly tied to that rate.
Despite six central bank rate cuts over the past two years, mortgage rates have largely remained elevated, generally fluctuating between 6% and 7% for a 30-year fixed-rate loan.
Potential homebuyers should understand that mortgage rates tend to move based on economic expectations long before the Federal Reserve actually changes policy. Given current Fed Chair Kevin Warsh’s reluctance to provide detailed guidance about future central bank moves, uncertainty in the housing market remains elevated.
“A lot of buyers think the next Fed meeting will tell them whether it’s a good time to buy a home,” said Bill Banfield, chief business officer at Rocket Mortgage. “In reality, mortgage rates are forward-looking. They’re constantly responding to what investors expect will happen in the economy, not just what the Fed announces on a given day. That’s why mortgage rates can fall before a Fed rate cut or even rise afterward.”
The Fed can influence mortgage rates more directly through a process known as quantitative easing, in which the central bank purchases mortgage-backed securities and other assets. The Fed used that strategy during the COVID-19 pandemic, helping push borrowing costs to historically low levels.
Currently, however, the Fed is not engaged in quantitative easing. Instead, it is maintaining its existing holdings while leaving short-term interest rates unchanged.
More directly, 30-year mortgage rates tend to track movements in the 10-year U.S. Treasury yield. The bond market, in turn, is influenced by several factors, including expectations for future Federal Reserve policy, economic growth and inflation.
In recent months, the U.S. war with Iran has added further inflationary pressure. Rising oil prices have increased costs across production, manufacturing and transportation. Higher energy prices can push inflation expectations and bond yields upward, which can then place additional pressure on mortgage rates as investors demand greater returns to compensate for inflation risk.
Last week, the 30-year U.S. Treasury yield climbed to a 19-year high of 5.238% following the Fed’s decision. Rising U.S. Treasury yields also contributed to higher European government bond yields, with the 30-year German Bund yield reaching a two-month high of 3.687%.
Analysts pointed in part to Warsh’s limited explanation for why rates were being held steady, which added to market uncertainty.
“Markets were giving Fed Chairman Kevin Warsh credibility on bringing down inflation following his first press conference in June,” wrote a TD Securities analyst. “The honeymoon period has ended with a bang as long-end rates have moved sharply higher amid a rebound in inflation expectations.”
Warsh’s approach of providing little forward guidance makes it more difficult for investors to form a clear view of future Fed policy.
Bond yields could remain elevated if hostilities in the Middle East continue to generate inflationary pressure and if investors begin questioning whether the Fed is prepared to act aggressively enough to contain rising prices.
The broader concern is that inflation could accelerate if the Federal Reserve does not raise rates sufficiently in the future.
Longer-dated Treasury securities were hit particularly hard following the meeting. The yield spread between 30-year and 2-year Treasurys widened to nearly 92.5 basis points by the following day’s close, up from roughly 78 basis points earlier in the session.
For borrowers looking for clues about where mortgage rates go next, the bond market may ultimately matter more than any single Federal Reserve meeting.
Lenders and investors have always demanded compensation for inflation risk, uncertainty and the time value of money. So while Federal Reserve policy remains important, mortgage rates are ultimately shaped by millions of investors making judgments about where the economy is headed.
Right now, those investors remain cautious.
