Explanation of the December Fed Rate Cut with Mortgage Interest Rates

The relationship between the Federal Reserve’s federal funds rate and mortgage interest rates isn’t always direct. Here are a few key reasons why mortgage rates can increase even when the Fed cuts its federal funds rate:
The current state of employment significantly impacts mortgage interest rates, as it ties directly to economic stability, inflation, and consumer demand. Here’s how:
1. Employment and Inflation Concerns
• Unemployment: When unemployment is low, consumer spending tends to increase. This can drive up inflation, prompting investors to demand higher yields on bonds, which in turn raises mortgage rates. Mortgage rates are more closely tied to the yield on the 10-year Treasury bond. If Treasury yields rise due to market factors like low unemployment, inflation expectations or increased government borrowing, mortgage rates can go up—even if the Fed lowers its rate.
• Rising Wages & Inflation: Higher wages boost disposable income, leading to increased spending and potential inflation. Mortgage rates often rise in response to inflationary pressures. Mortgage rates are highly sensitive to inflation. If investors believe the Fed’s rate cut could lead to higher inflation in the future, they demand higher yields on long-term bonds, pushing mortgage rates up.

2. Economic Uncertainty and Job Market Volatility
• High Unemployment: If unemployment rises, it signals potential economic slowdown. While this might push the Fed to lower rates, mortgage rates don’t always follow. Investors may see increased risk and demand higher yields on long-term loans, pushing mortgage rates up.
• Job Security Concerns: If people are worried about job stability, demand for mortgages may decline, which could stabilize rates. The quit rate is at an all time low while the continuing jobless claims is at a three year high.
3. Labor Market’s Role in Fed Decisions
• The Fed informed us that they are closely monitoring their dual mandate of employment & inflation data when setting policy. A strong labor market can lead the Fed to maintain or raise its federal funds rate to combat inflation, indirectly impacting mortgage rates. Conversely, a weak labor market might lead to rate cuts, but again, mortgage rates may not follow suit due to broader market dynamics.
4. Consumer Confidence and Housing Demand
• Strong employment & inflation supports consumer confidence, increasing demand for homes and mortgages. This demand can push mortgage rates higher, especially if supply is limited. If there’s a lot of demand for mortgages but limited supply of funding in the secondary mortgage market, rates will stay the same despite the Fed’s actions.
• Conversely, high unemployment erodes confidence, potentially softening housing demand and stabilizing rates.
5. The federal funds rate most directly impacts short-term rates, but it has an indirect effect on long-term rates like fixed mortgage rates through its influence on bond markets and inflation expectations.
• Prime Rate: The base rate banks charge their most creditworthy customers. Many loans, like credit cards, personal loans, and home equity lines of credit (HELOCs), are tied to the prime rate.
• Credit Card Rates: Variable credit card rates typically move up or down with changes in the federal funds rate.
• Auto Loans: These are often influenced by changes in short-term rates, though to a lesser extent than credit cards.
• ARMs and HELOCs are directly impacted by changes in the federal funds rate because they are tied to short-term benchmarks like the SOFR (Secured Overnight Financing Rate) or the prime rate. A Fed rate cut or hike will typically adjust the interest rate on these loans within months.
• Small business loans, Savings Accounts, CDs, and Money Market Accounts: When the federal funds rate increases, banks typically raise the interest rates they offer on deposits. Conversely, rate cuts lead to lower savings rates.

Current Implications
Right now, if the labor market remains tight and wages continue to rise, mortgage rates may stay elevated due to inflation concerns. However, if job losses increase or economic uncertainty grows, the Fed might adjust its stance, but mortgage rates could remain unpredictable, influenced more by bond markets than Fed actions alone.
The federal funds rate most directly impacts short-term rates, but it has an indirect effect on long-term rates like fixed mortgage rates through its influence on bond markets and inflation expectations.
The interplay between employment, inflation, and market dynamics makes this a critical factor in understanding mortgage rate trends. In summary, while the Fed’s actions influence the overall economy, mortgage rates are driven by broader market dynamics, particularly investor behavior in the bond market and inflation expectations.