How fun can I make a kind of dense/challenging economics lesson? Let's see!

I have been getting a lot of questions regarding how the Fed Funds Rate affects mortgage rates.

"So the Fed is cutting rates .25%, does that mean mortgage rates will go down .25%???"

One thing I want to point out is, the market is more savvy than ever, and Wall Street traders have the same data we do (and more!), so it is no surprise to anyone the Fed will be cutting rates soon. Most often these upcoming changes are already "priced in" meaning, current prevailing rates are already reflecting future changes expected to be made!

That being said, allow me to share my take on how the Fed Funds Target Rate (FFTR) will be impacting mortgage rates. 

If you want to skip to the ending, I believe mortgage rates will be heading down in the next 12 months - somewhere around 5.5% if I had to guess!

**PLEASE NOTE: as mortgage rates head down, more households will qualify to purchase homes with the more affordable payments, competition will rise, and so will house prices.**

Here's the fun part:

Does the Federal Reserve Set Mortgage Rates?

Not exactly.

The Federal Reserve (the Fed) does not directly set mortgage rates. Instead, it influences them through its monetary policy, particularly by setting the federal funds target rate (FFTR). Here’s a concise breakdown of how this works:

- Federal Funds Target Rate (FFTR): This is the interest rate at which banks borrow money from each other overnight. The Fed adjusts this rate to control economic activity, influencing the overall cost of borrowing money in the economy.

- Bank Borrowing: Banks may borrow from the Fed or each other to manage short-term liquidity needs, such as covering significant outflows like auto loans or deposit withdrawals.

- Impact on Consumer Rates: When the FFTR increases, the cost of borrowing for banks rises. Banks typically pass these higher costs onto consumers through increased interest rates on various loans, including auto loans, home equity lines of credit, and credit cards.

- Economic Conditions: If unemployment is rising (it is) and inflation is falling (it is), the Fed may lower the FFTR to stimulate the economy. Lowering the FFTR reduces borrowing costs, encouraging spending and investment, which can help stabilize the economy.

- Treasury Demand: A lower FFTR can increase demand for Treasury securities as investors seek fixed returns. Higher demand for Treasuries typically lowers their yields, which can indirectly reduce mortgage rates since mortgage bonds are often priced relative to Treasury yields.

- Mortgage Bonds: Mortgage bonds are considered riskier than Treasuries but are still influenced by Treasury yields. Historically, mortgage rates are about 1.5% higher than the 10-year Treasury rate. Currently, this spread is around 3%, but it is expected to narrow as the FFTR decreases. This would support mortgage rates around 5.5%, which would be pretty cool!!

Summary: While the Fed does not set mortgage rates directly, its policies significantly influence them. Lowering the FFTR can lead to lower mortgage rates indirectly through its impact on the broader financial markets and investor behavior.

Thus, mortgage rates may continue to fall over the next 12 months, not in direct proportion to the FFTR but as a result of its broader economic impact.

Here is a list of my sources: 

[1] https://www.nerdwallet.com/article/mortgages/fed-mortgage-rates

[2] https://www.cnet.com/personal-finance/mortgages/advice/how-the-federal-reserve-affects-mortgage-rates-in-2024/

[3] https://www.investopedia.com/articles/personal-finance/050715/how-federal-reserve-affects-mortgage-rates.asp

[4] https://www.amres.com/amres-resources/understanding-the-role-of-federal-reserve-in-mortgage-rates

[5] https://www.businessinsider.com/personal-finance/mortgages/how-does-fed-impact-mortgage-rates?IR=T&international=true&r=US

[6] https://www.federalreserve.gov/faqs/why-do-interest-rates-matter.htm

[7] https://www.cnbc.com/select/how-does-fed-affect-mortgage-interest-rates/