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Too frequently, media coverage suggests a Fed rate cut would coincide with lower mortgage rates and vice versa. But in practice it can be just the opposite! Let’s take a look at what the Fed is actually about to cut and how it might impact rates.
The Fed Funds Rate is set directly by the Federal Reserve. It’s the only rate people are talking about with respect to a “Fed rate cut.” The Fed Funds Rate applies to overnight loans between banks, credit unions and government sponsored enterprises. These loans aren’t covering shortfalls in the bank’s overall balance sheet (i.e. it’s not a payday loan), just shortfalls in the balances the banks hold at the Federal Reserve.
Nonetheless, the interest rate associated with these loans has profound effects on the financial market. Nothing does more to dictate the “cost of money” over the shortest time horizons. That cost radiates out to longer time horizons. Longer terms rates, like the 10yr Treasury Yield, are simply the market’s best guess at cash flows that will be generated by 10 years worth of the Fed’s overnight rate.
Needless to say, a lot can happen on any given day to make investors reassess short-term rate expectations over a 10 year time horizon. And while that reassessment is taking place, those investors might not see any near-term changes in store for short-term rates. When that happens, longer-term rates can move in one direction while short-term rates are holding steady (or even moving in the opposite direction).
This is the foundation of the discrepancy between the Fed Funds Rate and longer-term rates like those for mortgages. While it’s true that they each share a similar set of motivations, mortgage rates have to calculate and guess at how those motivations will evolve over time while the Fed Funds rate only has to worry about the here and now.
The “similar motivations” can be seen in the following charts which overlay mortgage rates and the Fed Funds rate. The first chart uses a different axis for each rate (so the lines can be visually closer together) while the two rates share the same axis in the second chart.
Yes, the blue and the orange lines look like they correlate in both these charts! So why does the title of this newsletter suggest a Fed rate cut could result in HIGHER rates?
The answer is quite simple. The two rates ARE correlated if we’re zoomed out to a wide enough time horizon. But life and home-buying/refinancing decisions don’t always wait for big-picture correlations to pan out. If we zoom in to a narrower time horizon, we can see just how UN-correlated the Fed Funds Rate and mortgage rates can be. 1999-2001 provides a classic example:
The fact that long and short term rates can operate on a different set of motivations is only part of the issue. The compounding issue is that the Fed is typically like a battleship in a river when it comes to making changes in the trajectory of rates. Not only do they only meet 8 times a year to discuss potential rate changes, they also strive to avoid making changes too quickly and risk responding to a head-fake in the economy.
With that in mind, consider that the Fed may be on the proverbial fence about making a change at one meeting only to decide it might be too early to do so. That means it will be another 6 weeks before their next chance to make the change!
In that 6 weeks, the bond market may become even more convinced that it has the Fed’s number–especially if the Fed offered some clues in its policy announcement about potential rate cuts in the future. That’s essentially what you’re seeing in the chart above where mortgage rates seem to lead the Fed Funds Rate.
This might all seem a bit crazy. After all, why can’t the Fed just change rates today if it’s going to change them at the next meeting anyway? Again, they really don’t want to make changes too quickly. Past precedent suggests that does more harm than good. They also don’t want to look like they’re oblivious to the motivations pushing for a rate cut. Fortunately, there are ways of balancing those considerations.
First off, the Fed can communicate its thoughts and intentions to prep markets for a potential change. That’s basically what happened in the June 19th Fed announcement and again this week in Fed Chair Powell’s congressional testimony. From there, markets can mathematically navigate around the slow-moving Fed is via something like the Fed Funds Futures market–a way for investors to hedge bets on the Fed Funds Rate at a certain point in the future. If we chart Fed Funds Futures versus mortgage rates, not only do we see the correlation we’d logically expect, we even see futures leading mortgage rates at times!
The high degree of correlation between these two lines means that we’ve already seen the drop in mortgage ratesassociated with the upcoming Fed rate cut. If we zoom in a bit, we might even conclude mortgage rates have a bit of catching up to do.
The takeaway is this: if Fed rate expectations for 2019 hold steady or increase, mortgage rates are more likely to move higher than lower, even though we could still see 2-3 rate cuts during that time.
Is there some sense of urgency about potentially rising rates here? Yes! Not only would I suggest not being lulled into a false sense of security by the fact that the Fed is likely to cut rates at the end of this month, I would also call your attention to a potential shift in the trend based on the same chart we discussed last week.
The chart shows how 10yr Treasury yields (the best benchmark for momentum in longer-term rates, like mortgages) bounced back from the “head-fake” last Thursday and then spent the entirety of this week adhering to the upwardly sloped trend line (the “winner”) from last week.
The second chart is from several weeks ago and it reminds us why a bounce at 2.00% would be troubling.
If it makes you feel any better, this week’s move in rates already got us a third of the way up to that ledge at 2.34%. Either way, it’s important to know that the path of rates has rapidly been getting back to economic fundamentals. That means the strength or weakness of incoming economic data will go a long way toward setting the tone for the next big move. If the data is resilient and/or stronger than expected, 2.34% would be a best-case ceiling.
That knife cuts both ways though. Weaker data would helprates avoid breaking much higher–if at all. And data that’s weak enough could give us another shot at 1.7% instead of (or shortly after) a visit to 2.34%.
now you’ve settled into your life. Have you been working for the same great company and moving up
the ranks since high school? Did you put that awesome idea into practice and now you have your own
thriving business? Maybe you graduated from college recently and started a career in your field of study.
Either way, you are living life how and more importantly where you want, and you feel you are
ready to settle into a home of your own for the first time.
It’s the American Dream: Owning your own home with the picket fence, the kids, and maybe a dog or
cat. But do you know all that goes into buying and owning a home? Do you know what your credit looks
like? Do you know what and how much money you need to save to pay for up front, for closing costs
and down payment? Have you even thought of budgeting for the expenses you’ll have after you buy the
home? Things like furnishing the home, maintenance and repairs, taxes and insurance, and utility bills
like water and sewer, gas, electric, trash, and maybe HOA dues.
This all can be a lot to take in, especially on your own. There are many great resources out there for
first-time buyers that will help you to answer these questions and more. One of those resources is
through the HRDC. In these courses, you’ll be taken through the steps of
the home-buying process, as well as getting some financial education on what owning a home can
entail. These classes also provide education on how to budget for the many variables involved in owning
a home. First, on purchasing the home and how to save the adequate amount of money for both down
payment and closing costs. Secondly, on how to budget and save for the expenses that go into owning
and maintaining your new home. You’ll learn about credit, what it means, and how it is used in decision
making and the minimum requirements needed for different programs. They cover why having a realtor
can be beneficial in both how they help you find a home that meets both your needs and price range,
and how they help with what can be a complicated contract process to make offers on homes you like.
The classes also talk about choosing a lender and the available loan options.
Your lender will also be a wonderful resource, and Caroline at GoPrime Mortgage has been in the
industry here in Bozeman for 13+ years now. She has experience with both first-time buyers and folks
that have gone through the process several times. Caroline can help you understand everything you’ll
experience during your Bozeman homebuying process and everything you need to know before you
start. Caroline will go over your credit with you and cover the details of what makes up your cores as
well as ways to improve if possible. She also goes over the steps of the home buying process that include
- Getting pre-approved and the documents you will need to give to your lender
- Finding and offering on the home you want
- Going through home inspections and appraisals, what these are, and how they benefit you
- Shopping for and choosing the appropriate homeowner’s insurance
- The closing process and getting your funds to closing.
At GoPrime Mortgage, we will work with you from start to finish. For us, the old adage of “no such thing
as a dumb question” really is true. We will work with you every step of the way to make sure you feel
comfortable and knowledgeable about the choices you have and the direction you should pursue. At
GoPrime, our top priority is to make sure we build that relationship so that we can be a resource for
your first, second or 10th home over your lifetime in real estate.
Interest rates have been on a tear. They’ve fallen faster and farther than at any other time in the past 8 years. By some measures, they’ve managed to maintain positive momentum for as long as they ever do. This naturally begs the question: is it time for a bounce?
Investors expected some clarity on that question from this week’s economic data. This was the first look at several of the most important reports since the last Fed meeting. At that meeting, the Fed acknowledged investor expectations for rate cuts in 2019, but on the condition of lackluster economic data.
In that regard, this week provided some massively mixed messages. At first, it looked like the data would indeed endorse a continuation of the trend toward even lower rates. The Institute for Supply Management (ISM) released its Purchasing Managers Indices (PMIs) for the manufacturing and non-manufacturing sectors on Monday and Wednesday respectively. Although they weren’t very far from forecasts, both qualified as lackluster as they did nothing to challenge the notion that we’re in one of the weaker patches of the economic cycle.
ISM PMIs are two of the most important monthly economic reports in terms of the ability to influence interest rates. They’re second only the Employment Situation (aka “the jobs report” or “NFP” for its headline component: nonfarm payrolls) and occasionally the ADP Employment Report, which can be used as an early indicator for NFP.
ADP and NFP were more closely watched than normal this week because both were quite a bit lower than normal last time around. ADP was first up on Wednesday. While it didn’t convey quite as much weakness as last time, it was weak enough to keep rates at long-term lows (and to keep anticipation running high for Friday’s NFP number).
NFP also bounced back, but in much grander fashion than ADP, coming in at 224k compared to 72k last month–handily beating the median forecast of 160k.
Whereas Wednesday’s data helped rates to break below the recent trend of “higher lows” (lower red line in the following chart), Friday’s jobs data completely reversed those gains.
At first glance, that may look like defeat for fans of low rates. Indeed, that may prove to be the case in the coming days. But Friday’s rate spike stalled out at a level that leaves some room for hope. In terms of the 10yr Treasury yield (the best benchmark for momentum in long-term rates like mortgages), rates bounced perfectly on the ceiling that’s been intact since the June 19th Fed meeting.
All that to say that although the jobs report raises doubts as to just how eager the Fed should be to cut rates, investors aren’t giving up on the idea easily. That makes good sense considering the economic picture is too complex for a single economic report to adequately capture. The jobs report may remove some apprehension about a shift in the labor market, but it doesn’t magically erase weakness seen in other reports.
The most important repercussion of this week’s data is for the Fed. Had NFP been weak, it would have been an easy call for the Fed to cut rates in their meeting at the end of July. Had the ISM and ADP data been as strong as NFP, leaving rates unchanged would have been a similarly easy call. As it stands, the implication is somewhere in between. We’ll have a great sneak peek at the Fed’s thought process in light of this data when Fed Chair Powell delivers his semi-annual congressional testimony on Tuesday and Wednesday next week.