Why Mortgage Rates Are Rising Despite Fed Rate Cuts

The housing market is constantly in flux, and recent trends in mortgage rates have been a source of confusion for many.  While the Federal Reserve has been cutting interest rates, mortgage rates have actually been rising.  Let's delve into the reasons behind this seemingly contradictory trend and explore the potential impact on the housing market.

The Connection Between Bond and Mortgage Rates

The benchmark 10-year Treasury rate rose by as much as 18 basis points the day after the election, pushing the overall rate on the bond to 4.47%. The price of bonds and their yield move inversely, with prices falling as rates rise. For example, if you have a $100 bond paying 10% and then rates rise to 20%, the original $100 at 10% becomes less valuable because now investors could get a $100 bond that pays 20%. A rising yield on Treasury bonds raises the cost of the U.S. federal government when it borrows new money or rolls over existing debts. In short, the cost of borrowing increases and, therefore, more money is needed to pay interest rather than paying for tangible government programs. 

The 30-year mortgage rate trends with the 10-year Treasury rate, usually about 2% higher. As of November 7, 2024, the average 30-year mortgage rate was 6.79%, a significant increase from 6.08% at the end of September. In just over a month’s time, the monthly payment on a $500,000 loan increased 7.7%. 

The Role of Inflation

But the question you may be asking is, why did rates go up even in the wake of the Fed cutting the federal funds rate? Real interest rate returns account for inflation, so the $100 bond at the nominal rate of 10% can be rewritten as 10% minus inflation (currently 2.4%) to get the real return of the investment. If inflation is expected to rise, the nominal rate can increase, so real return is unaffected or, at least, less affected, in which case real return would decrease. 

Trump’s economic plans are inflationary and, therefore, increase rates. The U.S. economy is operating at close to capacity, and unemployment is low. Tax cuts will increase demand, but higher tariffs will push up prices. The U.S. is a net importer, so blanket tariffs will drive up the prices of an incredible number of day-to-day goods. Higher inflation will result, meaning the Federal Reserve will be more cautious about cutting interest rates. 

Impact on the Housing Market

Currently, mortgage rates rise higher when the housing market already tends to slow. Typically, the holiday season experiences fewer sales then picks up again in January. A month ago, rates were dropping, and we were extremely bullish on the spring market. However, if rates rise above 7% or higher, the market will be slower than usual. Since the market has already been slower than usual, a further slowdown coupled with higher inflation would likely slow price growth next year. 

The recent rise in mortgage rates, despite the Fed's interest rate cuts, highlights the complex interplay of economic factors, including inflation and the bond market.  While the Fed's actions can influence mortgage rates, other factors, such as inflation expectations, can also play a significant role.  The potential impact on the housing market remains uncertain, but the combination of higher rates and a slower market could lead to a slowdown in price growth in the coming year.  Stay informed about market trends and consult with a real estate professional to navigate this dynamic environment and make informed decisions.