The Federal Reserve’s interest rate cut last week has led many to wonder what it means for mortgage rates. The housing website Redfin noted that some would-be homebuyers aren’t aware that we’ve already seen a steep decline, while others are waiting for mortgage rates to fall more.
So it will surprise some home seekers out there that 30-year mortgage rates were broadly flat to a touch higher last week even with the Fed’s bigger-than-expected half-a-percentage-point cut. This is because markets and the Fed now agree that in a “softish” economic landing, the fed funds rate is likely to eventually fall to around 3%, well above pandemic-era levels. That limits how much mortgage rates can decline — particularly by next spring’s housing season — after dropping to 6.15% from 8% over 11 months. Those hoping for much lower should be careful what they wish for: A world of substantially lower mortgage rates is one of substantial job losses.
The agreement between markets and the Fed on the ultimate destination of interest rates has only emerged over the past few months. As recently as this spring, markets were betting on a “higher for longer” stance, with futures pricing the fed funds rate at the end of 2025 as high as 4.4%. At the time, inflation was somewhat elevated, the labor market looked mostly strong and stable, and it still wasn’t clear when the Fed might begin cutting rates.
Since then, inflation has continued to cool, the unemployment rate has risen to 4.2% from 3.8%, and the Fed has kicked off its easing cycle. Markets shifted from thinking about when the Fed will begin cutting to how much it will ultimately cut. Both now agree on the ultimate level, with the only difference being timing — markets estimate policymakers will get there by the latter part of 2025 rather than the end of 2026.
This signals that the 10-year Treasury yield, which mortgage rates are tied to, is likely near its floor unless the economy starts to slow markedly. There’s still room for mortgage spreads — the difference between mortgage rates and the level of the 10-year yield — to narrow, but it suggests the decline in mortgage rates is closer to the end than the beginning. Any further decline in spreads may not be as rapid or as large as is hoped for. The current gap, a bit north of 2.40 percentage points, compares with an average of about 1.75 through the 2010s.
Additionally, a lot of capacity came out of the lending and mortgage origination system as sales and refinancing slumped in the past two years. It will take time to rebuild that supply chain and pricing competition as demand returns. Employment in “credit intermediation and related activities” has been declining on a year-over-year basis since early 2022, and while the government doesn’t have good data looking only at workers involved in processing mortgage loans, that category has presumably been hit even harder. Mortgage applications have started to recover but remain 35% below levels of a normal year like 2017.
Thinking ahead to next spring’s housing season, if one assumes mortgage spreads narrow half the way to levels seen in the 2010s, and the 10-year yield bottoms around current levels, 30-year mortgage rates could drift toward 5.75%. That’s a welcome improvement from the past two years but will disappoint those hoping to see rates back in the 3s or 4s.
The wild card here is the labor market. In the Fed's latest Summary of Economic Projections, the forecast for the unemployment rate by year end was raised to 4.4% from 4%. There’s no guarantee it stops there. Should the unemployment rate rise closer to 5% next year, the market and Fed would lower estimates for where the fed funds rate ends up and mortgage rates would likely fall, too. But that would mean the economy is no longer in a soft landing, and there’s no telling who keeps their job in that environment and can capitalize on a lower mortgage rate.
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