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Fed’s 50 bps rate hike could trigger falling mortgage rates

Federal funds rate set at the 4.25%-4.50% range is welcome news for the housing market

After inflation slowed more rapidly than expected in November, the Federal Reserve raised the federal funds rate by 50 basis points on Wednesday to 4.25%-4.50%, a smaller interest rate hike than the 75 bps per meeting the Fed policymakers have stuck to since June.

This slowdown is good news for the housing industry, as it may lead to a decline in mortgage rates.

The decision from the two-day Federal Open Market Committee meeting is, all things said, encouraging news for the housing market, which has suffered from elevated home prices, a lack of inventory and high mortgage rates that have chilled activity.

Fed chairman Jerome Powell on Wednesday noted that “the appropriate thing to do now is to move to a slower pace.”

Policymakers now expect to lift borrowing costs to 5.1% by the end of 2023, up from a projected 4.6% in September when estimates were last published. Fed officials do expect to begin lowering rates in 2024, but they anticipate bringing them down slowly.

While Powell said that it will take time for the full effects of the monetary restraint to be realized, the chairman noted that policymakers are “seeing the effects on demand in the most interest-sensitive sectors of the economy, such as housing.”

Housing services inflation has been very very high and will continue to go up before coming back down sometime next year, Powell said of the industry that has been in a recession.

“As rents expire and have to be renewed, they are going to be renewed into a market where rates are higher than they were when the original leases were signed,” he said. “But we see that the rate for new leases are coming down, so once we’ve worked our way through that backlog, that inflation will come down sometime next year.”

Powell reiterated the central bank’s commitment to increasing interest rates to bring inflation to 2%.

“We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive, to return inflation to 2% over time,” Powell said.

In determining the pace of future increases in the target range, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments, according to the FOMC statement. 

“In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May,” the statement said.

The Fed’s mission to fight surging inflation started in March when the central bank raised the benchmark rate by 25 bps. That rate increase was followed by a hike of 50 bps in May, four straight hikes of 75 bps hikes in June, July, September and November, and a 50 bps increase in December. 

The central bank targets 2% inflation on an annual basis, but price increases were running at about three times that pace this year through October, based on the Personal Consumption Expenditure price index – the Fed’s preferred inflation gauge.

The Consumer Price Index, a more timely inflation measure, showed inflation slowing more rapidly than expected in November. The CPI rose 7.1% year over year in its lowest reading in a year. Year-over-year consumer price inflation peaked at 9.1% in June, but price growth has declined since then, slowing from October’s 7.7% and landing lower than economists’ expectations of 7.3% in November. 

On the back of encouraging signs that inflation-fighting measures are working, investors have speculated that central bank policymakers would pursue a less aggressive policy path in 2023. 

Excluding the volatile food and energy prices, the so-called core CPI rose 0.2% from October and 6% on an annual basis, according to the Bureau of Labor Statistics

Services inflation, which tends to move in correlation with rising wages, remained strong due to rapid increases in rent, which rose 7.9% year over year. The labor market also remains robust, as employers added 263,000 jobs in November and unemployment levels are at 3.7%.

Indication for mortgage rates

While the Fed’s short-term rate does not directly impact long-term mortgage rates, it does steer market activity to create higher rates and reduce demand.

Mortgage rates have been declining after peaking past 7% levels in October following slower-than-expected inflation readings that month. The 30-year fixed mortgage rate declined to 6.30% on Tuesday, according to the HousingWire Mortgage Rates Center.

Mortgage demand rose 3.2% last week, which was driven by increases in purchase and refinance activity compared to the previous week as financial markets reacted to mixed signals regarding inflation and the Fed’s next policy moves, according to the Mortgage Bankers Association.

However, with rates more than three percentage points higher than a year ago, both purchase and refinance applications are still well behind last year’s pace, said Joel Kan, vice president and deputy chief economist at the Mortgage Bankers Association. 

“At this point, mortgage rates have fallen 1%, with the markets knowing we still have some more Fed rate hikes coming,” Logan Mohtashami, lead analyst at HousingWire, said. 

The market has baked in a 50 bps rate hike — and that is “the right call” after the weaker CPI reading, he added.

“The ongoing moderation in home-price growth, along with further declines in mortgage rates, may encourage more buyers to return to the market in the coming months,” Kan said. 

The MBA expects the average 30-year fixed mortgage rate to fall to 5.2% in 2023. The latest MBA forecast showed mortgage rates will finish the year at 6.7%.

The next two-day FOMC meeting is scheduled for January 31 and February 1.

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