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Fed Raises Target Rate Again, but Mortgage Rates Are Unfazed

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Inflation has been making both owning and renting more expensive, forcing many Americans to spend more of their monthly budgets on housing.

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The Federal Reserve doubled down on its inflation-fighting strategy on Wednesday afternoon, raising a key interest rate by 75 basis points, or 0.75 percentage point, for the second month in a row. The good, or at least not worse, news for home buyers: The Fed's latest move doesn't seem likely to push up mortgage interest rates, and the housing market may be beginning to normalize after two-plus years of cutthroat competition and runaway price increases.

A dramatic first half of the year for rates

Adjusting the federal funds rate is one of the Fed's main tools for taming inflation by making it more costly to borrow money, hence rising interest rates. After keeping the rate near zero since March 2020, the Fed raised it first by 25 basis points in March, then 50 in May and 75 in June. One basis point is one one-hundredth of 1 percentage point.

At the same time, mortgage rates began rising far more quickly than experts had predicted for 2022 as lenders and the broader economy reacted to the Fed's moves. Rates for 30-year fixed-rate mortgages went from below 4% in early March to nearly 6% in June, according to Freddie Mac.

Banks use the federal funds rate to determine what to charge each other for overnight lending. While mortgage rates aren't directly indexed to the funds rate, changes to this key rate radiate outward to other types of borrowing. That means consumers may be less inclined to make big purchases, such as houses, and businesses might be less likely to hire or expand.

That sounds painful for the economy because it is. But at this point, the central bankers feel they need to bring the pain. Despite the three previous rate increases, inflation has continued to accelerate. The Federal Reserve considers 2% a healthy rate of inflation, and the U.S. Bureau of Labor Statistics July 13 report showed inflation in June at 9.1% — the largest year-over-year increase in 41 years. This set the stage for today's rate hike.

Mortgage rates becoming less volatile

While mortgage rates have risen dramatically in 2022, each successive Fed announcement has brought a smaller reaction. As sizable and frequent Fed increases have become more predictable, the market seems to be pricing them in more routinely.

"When the Federal Reserve raised its short-term interest rates in March, mortgage rates surged about 80 basis points in the next following three weeks. As a result, the 30-year fixed mortgage rate rose from 3.9% to 4.7% by the end of March," Nadia Evangelou, senior economist and director of forecasting for the National Association of Realtors, explained by email.

"However, when the Federal Reserve raised its rates again more aggressively in May, mortgage rates increased by less than 20 basis points, and then rates fell to 5.1% by the end of May," she said. "Thus, the data shows that the effect of the Fed's rate hike on mortgage rates was smaller in May than in March. Respectively, in June, even though rates surged after the Fed's announcement, mortgage rates fell back near 5.3%."

But mortgage interest rates respond to forces other than the Fed, including domestic economic headwinds and global factors such as the war in Ukraine and continued supply chain disruptions. As a result, a lack of predictability is the common thread among many mortgage rate predictions these days.

"The federal funds increase will have little to no effect on mortgage rates," Robert Frick, corporate economist at Navy Federal Credit Union, said in an email.

"Mortgage rates are tied to the 10-year Treasury yield, which is determined by the markets based on a number of factors, including inflation and the overall health of the economy," he said. "Given the trajectory of both inflation and the economy are so uncertain now, mortgage rates are being whipsawed."

What this means for home buyers

Though inflation hasn't yet been vanquished by the Federal Reserve's strategy, as mortgage rates show, the central bankers have made it more expensive to borrow money. That's beginning to shift the housing market away from the wildly unstable conditions of the past couple of years when home buyers encountered increasingly long odds.

"Prices are softening, overpriced homes are reducing their prices, but well-priced homes are still selling," Melissa Cohn, regional vice president at William Raveis Mortgage based in New York City, commented in an email.

"With inventories still well below the norm and the millennial generation kicking their homebuying into high gear," she added, "real estate prices won't crash. There is still demand in the market."

Inflation has made both owning and renting more expensive, forcing many Americans to spend more of their monthly budgets on housing. But Evangelou pointed out that for those able to buy now, a home can be a hedge against inflation. "With a fixed-rate mortgage, the monthly payment remains the same," she said. In that regard, "homeownership helps people stabilize their housing costs. If buyers are financially ready, they shouldn't hold off from purchasing a home."

And interest rates aren't forever — while buyers shouldn't expect the ultra-low rates of 2020 and 2021 to return, if rates drop in the future, you're just a refinance away from a lower mortgage payment.

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