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Fed's big rate hike might not further impact mortgage rates

Federal Reserve policymakers approved the biggest short-term interest rate hike in 28 years Wednesday and signaled they’re prepared to keep raising rates until inflation comes down closer to the Fed’s long-term goals.

The 75 basis-point increase in the federal funds rate followed Friday’s release of a Labor Department report that showed inflation hitting 8.6 percent in May — the highest reading in more than 40 years, and far above the Fed’s long-term target of limiting inflation to no more than 2 percent.

The alarming inflation numbers triggered a bond market sell-off on Friday and Monday that sent mortgage rates surging above 6 percent on fears of more drastic Fed tightening.

But long-term rates held steady Wednesday, with bond markets have already priced in the Fed’s drastic move, which Fed Chairman Jerome Powell acknowledged was “unusually large.”

“Clearly today’s 75 basis-point increase is an unusually large one, and I do not expect moves of this size to be common,” Powell said at a press conference Wednesday. At the Fed’s next meeting, which wraps up on July 27, Powell said “either a 50 basis-point or a 75 basis-point increase seems most likely … we will, however, make our decisions meeting by meeting and we’ll continue to communicate our thinking as clearly as we can.”

“Making appropriate monetary policy in this uncertain environment requires a recognition that the economy often evolves in unexpected ways,” Powell added. “Inflation has obviously risen to the upside over the past year, and further surprises could be in store. We, therefore, will need to be nimble in responding to incoming data and the evolving outlook.”

While the Fed has direct control over the short-term federal funds rate, rates on long-term investments, such as Treasurys and mortgage-backed securities, are largely determined by investor demand. When investors lose their appetite for bonds that fund most mortgages, that drives yields up.

Yields on 10-year Treasurys, a barometer for mortgage rates, hardly budged after the Fed’s announcement and remained below Tuesday’s close of 3.48 percent. A daily index of mortgage rates compiled by Mortgage News Daily showed rates for 30-year fixed-rate mortgages retreating slightly Wednesday, to 6.22 percent.

“The Fed managed to hint at today’s move despite the blackout period encompassing Friday’s inflation surprise, with the market correctly adjusting to forecast today’s 75 basis-point hike,” said Phil Rasori, chief operating officer at Mortgage Capital Trading, a San Diego-based capital markets advisory firm, in a statement. “The challenge now before the Fed is retaking the narrative that they are on top of rising inflation, which will persist along with market volatility until the data indicates peak inflation has been reached.”

Robert Heck, vice president of the mortgage at Morty, had a similar take. “There’s no question that this is some of the most aggressive action we’ve seen the Fed take in recent times, but the bond market (in particular mortgage rates) are much further ahead of the actual fed funds rate,” Heck said, in a statement provided to Inman. “Any persistent/obvious signs of a wage or inflationary spiral will continue to lead to more aggressive policies. In these extreme scenarios, it is very possible we’ll see mortgage rates head towards 7 percent or higher.”

In their announcement, Fed policymakers serving on the Federal Open Market Committee said they are “highly attentive to inflation risks.”

“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the committee’s statement said. “The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions.”

Lawrence Yun, the chief economist for the National Association of Realtors, predicted that “Only when consumer price inflation tops out and starts to fall will mortgage rates stabilize or even decline a bit. That is why providing additional oil supplies will be critical in containing consumer prices and interest rates.”

The Fed approved the first short-term interest rate hike since 2018 March, raising the federal funds rate by 25 basis points, or one-quarter of a percentage point. That move was followed by a more dramatic 50-basis point hike on May 4, the biggest short-term interest rate hike in 20 years.

In announcing Wednesday’s 75 basis-point increase in the federal funds rate, to a target range of 1‑1/2 to 1-3/4 percent, Fed policymakers said they anticipate that “ongoing increases in the target range will be appropriate.”

As previously announced, the Fed also made clear that it intends to continue paring down its nearly $9 trillion balance sheet, by letting Treasurys and mortgage-backed securities it bought to keep interest rates low run off its books.

Mortgage rates were already on the rise in June as the Fed embarked on its “quantitative tightening” program, to let debt roll off its nearly $9 trillion balance sheet.

The Fed’s $9 trillion balance sheet

Assets held by the Federal Reserve through quantitative easing purchases now include $5.77 trillion in long-term Treasurys and $2.71 trillion in mortgage-backed securities. Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis.

On June 1, the Fed began reducing its $2.71 trillion in mortgage investments by letting up to $17.5 billion in maturing assets roll off its books each month. The plan is to ramp the pace of tightening up over three months, to $35 billion a month. The caps for Treasury roll-offs will be higher — $30 billion a month at first, increasing to $60 billion a month after three months.

Mortgage rates surge past 6%

According to the Optimal Blue Mortgage Market Indices, rates on 30-year fixed-rate mortgages have increased by nearly 3 full percentage points in the last year, rising from 3.161 percent on June 15, 2021, to 6.056 percent on Tuesday.

In the last two weeks alone, mortgage rates have soared by 79 basis points. A basis point is one-hundredth of a percent, so mortgage rates have increased by nearly eight-tenths of a percentage point in the last two weeks.

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