The Fed announced today an interest rate hike of .25 to the Fed funds rate. This brings the Fed funds rate to 5.5%, the highest level in 22 years, as the Fed continues to fight against stubbornly sticky inflation. In commentary following the hike, Fed officials noted they’ll watch inflation and monitor the overall marketplace before deciding on the next move after meeting on September 20. As of today, a .25 hike or a freeze on hikes is expected at the next meeting, pending inflation numbers and other economic reports that will be released between now and then.
What does the Fed funds rate affect?
For most people, the biggest effect of the Fed funds rate increase is felt in the cost of credit. Credit card rates are tied to the prime rate (your credit card charges interest based on a prime rate +/- formula, and the Fed funds rate directly impacts the prime rate. So if your credit card rate is prime rate + 1%, the prime rate just increased .25%, so your credit card rate would also see a .25% increase.
Home equity lines of credit are also often tied to the prime rate, so rate changes are seen & felt in direct correlation to the Fed moves. Payments on both credit cards and home equity lines of credit will see an increase due to the Fed move.
Does the Fed affect mortgage rates?
Yes, and no. While the Fed’s moves often move mortgage rates, there’s not a direct correlation, and there’s often an opposite impact seen. That is, when the Fed raises the Fed funds rate, mortgage rates head down (which is what we saw today – modest improvements to mortgage rates on the Fed announcement). This is primarily due to the Fed’s rate hikes being a tool to fight inflation. Mortgage rates are tied to inflation, and when inflation rises, mortgage rates also rise. The opposite is also true. This is why over the past 18 months as inflation has spiked, mortgage rates have also risen drastically. If and when inflation falls, we should expect to see mortgage rates move downward as well.
When will mortgage rates drop?
Mortgage rates are impacted by many different things, some of them opposing forces. While we’re beginning to see inflation subside, it has remained stickier than anticipated and still remains at levels higher than the Fed prefers to see them. The broader economy is still showing signs of strength as well, especially in the jobs market. If the economy should begin showing cracks or signs of weakness, this could speed up the fall of mortgage rates, an occurrence widely expected in the markets in the not so distant future, with varying timeframes being predicted by various economists. One opposing force helping to keep mortgage rates high is the sale of mortgage backed securities by banks as a means to raise capital. With higher supply of mortgage backed securities on the market, it pressures prices low, therefore keeping rates high. This, however, is likely to take a backseat to broader economic news should inflation fall and the jobs market start to weaken in the coming months. Many forecasters have predicted rates will be in the 5s by year end, but many forecasters have been wrong in their timing over the past 12 months so it remains to be seen if these predictions will bear any fruit.
For now, though, rates are at 22 year highs, and it will take several months for the impacts of today’s move to be felt in the broader economy. The Fed has a challenging position of maintaining a dual mandate of stable inflation and maximum employment for the economy, and they’re in a tough spot of deciding when enough is enough in terms of rate hikes, with the impacts of hikes taking several months to actually show economic impacts. If they hike too much or too fast, it could cause a recession, and if they don’t hike enough, inflation could continue to be a challenge. The next few months will be important in terms of mortgage rates and the broader economy, with our focus being on inflation numbers and employment reports between now and the September Fed meeting.