Banks can be unpredictable, as this week clearly illustrates. On December 18, the Federal Reserve made a move to cut short-term interest rates. Surprisingly though, mortgage rates headed in the opposite direction, ticking upward.
Specifically, the average 30-year fixed mortgage rate nudged up by 0.12 percentage points during the week ending December 18, settling at 6.66%. Meanwhile, the Fed decided to decrease the federal funds rate by 0.25 percentage points.
Typically, mortgage rates and the federal funds rate tend to follow the same trajectory. Yet, there are moments when they part ways, like this week. This divergence often occurs because these rates are based on different time horizons. When you secure a 30-year mortgage, lenders are thinking about the long-term economic outlook. On the flip side, the federal funds rate is what banks charge each other for overnight loans, reflecting a very short-term perspective.
The mortgage market appears convinced that high inflation will linger, driven by a strong economy. The Fed, contrastingly, seems optimistic that inflation will gradually slide down to its target of 2%. In its December 18 statement, the Fed’s rate-setting committee acknowledged, “Inflation has made progress toward the Committee’s 2% objective but remains somewhat elevated.”
In essence, there’s a fog of uncertainty surrounding the economic future, especially with a new presidential administration about to take office in January. “At the moment, fiscal policy seems to be the key driver behind rate movements,” remarks Chen Zhao, head of economic research at Redfin, a real estate brokerage. Should tax cuts and new tariffs come into play, they could usher in higher prices, and historically, when inflation rises, so do mortgage rates.
The financial markets, including the mortgage sector, appear to be anticipating fiscal stimulus in the form of tax cuts, which might spark inflation. Post-election, investors seem less concerned with potential higher tariffs or large-scale deportations, both of which could bring about higher prices coupled with stagnant economic growth. This troubling combination was labeled “stagflation” back in the 1970s, culminating in back-to-back recessions between 1979 and 1982. Investors, however, don’t seem particularly anxious about revisiting this period from history.
In a December 17 column, James Mackintosh, senior markets columnist at the Wall Street Journal, noted the prevailing “euphoric sentiment.” Not with unbridled optimism, but more like a cautious chaperone at a prom keeping an eye on the punch bowl. Mackintosh cautioned that “trouble might be imminent for stocks.”
While investors get carried away with expectations, pushing interest rates up in anticipation of the next administration’s policies, the Federal Reserve stands by its principle of responding only to enacted fiscal policies. The Fed tries to project an image of carefully considering facts over speculation.
However, it’s worth noting that the inflation rate edged higher in October and November, casting some doubt on the Fed’s confident belief that inflation is on track to meet its 2% target. If the Fed’s predictions hold true and inflation takes a downturn, mortgage rates should eventually decrease, too. For now, though, inflation and mortgage rates remain stubbornly higher than anyone would like.
