The Fed Cut Rates. Mortgage Costs Went Up. Why?

In an unexpected turn of events, mortgage rates have surged despite the Federal Reserve's recent rate cuts. This counterintuitive trend has left many homeowners and prospective buyers scratching their heads. Let's delve into the reasons behind this phenomenon and explore what it means for the housing market.

The Federal Reserve's rate cuts were aimed at lowering short-term interest rates, which typically influences consumer borrowing costs. However, mortgage rates are primarily determined by the yield on 10-year Treasury bonds, not the federal funds rate. This disconnect between the Fed's rate cuts and mortgage rates can be attributed to several factors.



1. Reduced Appetite for Mortgage-Backed Securities (MBS): Most mortgage lenders package loans into MBS to sell to investors. When demand for MBS is low, prices fall, leading to higher mortgage rates. Post-pandemic, MBS demand has decreased, contributing to the widening mortgage-Treasury spread.
2. Rising Prepayment Risk: Homeowners often refinance when rates drop, shortening loan durations and causing lenders to price longer-term loans with shorter-term rates. This increased prepayment risk has also contributed to the wider mortgage-Treasury spread.
3. Investor Expectations on Future Fed Monetary Policy: When the Fed signals a slower pace of rate cuts, as seen in the latest Summary of Economic Projections, it can lead to a rise in mortgage rates. Investors anticipate higher long-term interest rates, driving up the 10-year Treasury yield, which directly impacts mortgage rates.

Understanding these factors is crucial for investors and homeowners alike. While the Fed's rate cuts may not directly influence mortgage rates, they do play a role in shaping investor sentiment and, consequently, mortgage rates. As the economy continues to evolve, so too will the relationship between the Fed's monetary policy and mortgage rates.

In conclusion, the recent surge in mortgage rates, despite the Fed's rate cuts, can be attributed to a combination of reduced MBS demand, rising prepayment risk, and investor expectations on future Fed monetary policy. As these factors continue to shift, so too will the mortgage market, presenting opportunities and challenges for investors and homeowners alike. Staying informed about these dynamics is essential for making well-informed decisions in the ever-changing housing market.