October 1, 2022


It’s bad enough that Southern California home prices remain high despite reduced demand, averaging nearly seven times the state’s median income for a family of four.

The situation is worsened, however, by the rapid growth of interest rates on mortgages. The rate on a 30-year fixed-rate mortgage has doubled in nine months, hitting 6% last week, the first time since George W. Bush’s presidency.

That’s painful not only for people trying to borrow money to buy a home, but also for homeowners with adjustable-rate mortgages, whose monthly payments go up every year when interest rates rise.

Two factors in the increase were inflation and efforts by the Federal Reserve Board of Governors to tame it. The Fed has raised the short-term “federal funds” rate (the interest rate banks charge each other for overnight loans) four times this year and is expected to do so again on Wednesday.

David Wilcox, senior economist at the Peterson Institute for International Economics and Bloomberg Economics, said a key factor in mortgage interest rates is how much inflation lenders expect to see over the life of the loan. And given the Fed’s messages and continued inflationary pressures in the economy, financial markets expect a higher path for interest rates in the coming years than they did earlier in 2022.

So should you expect to pay even more for a new mortgage after the Fed imposes its latest hike? Possibly, but there is no simple cause and effect here. Instead, the Fed’s moves affect mortgage rates indirectly by affecting the expectations of lenders and financial markets.

Consider what happened after the Fed raised its target interest rate by 0.75 percentage points in June, the largest increase yet since 1980: Mortgage rates have fallen. They started rising again a few weeks later in anticipation of the Fed meeting in July, when it raised its target for the second time by 0.75 percentage points. And after that, mortgage interest rates fell again.

This illustrates how financial markets run ahead of the Fed, reacting to expectations rather than waiting for the central bank to react. And when the Fed meets those expectations, “typically you see some kind of bailout,” said Robert Heck, vice president of mortgage at Mortyonline mortgage broker.

The Fed is trying to break the economy’s inflationary fever without pushing the country into recession, but the usual indicators of economic health are confusingly mixed. Gross domestic product is falling, but unemployment remains low; corporate profits are mostly solid; consumer confidence is recovering; and consumer spending continues to growthough slowly.

Fed Chairman Jerome H. Powell has repeatedly said that the Fed will raise interest rates until inflation is under control. Still, some lenders and investors looked at the economy in July and thought the Fed would take its foot off the monetary brakes, Heck said.

That changed in August, however, when Powell and other Fed officials reiterated their determination that, as Powell put on August 26, “keep it up until we’re sure the job is done.” Intentionally or not, the statement reflected the title the memoirs of former Fed chairman Paul Volckerwho used high interest rates to pull the US out of double-digit inflation in the 1980s.

“I think the Fed has been able to communicate more clearly and the market has bought more and more thoroughly their determination to fight inflation and win the battle,” Wilcox said.

At the same time, Wilcox said, “the market concluded that the Fed was going to have to do more to win that fight.”

Recent data show that inflation is broader and more stubborn than previously believed, and the labor market remains “remarkably robust,” he said.

Nor did any of the newly released economic data point to lower interest rates, Heck said.

Hence the steady rise in interest rates on mortgages since the beginning of August.

Another reason for the increase, Heck said, was speculation that the Fed could raise the federal funds rate by an even larger amount on Wednesday — 1 to 1.25 percentage points. “I think this meeting was probably the one we were least prepared for, in terms of knowing what was going to happen,” Heck said.

One key to market reaction will be “plot point“, or a chart showing how much Fed officials expect the federal funds rate to increase or decrease over the next few years. Powell said he expects the federal funds rate to reach 3.4% by the end of this year – at Wednesday’s meeting, it was in a range of 2.25% to 2.5%.

Another important question, Heck said, will be what Fed officials say about holding mortgage-backed securities at the central bank. Earlier this year, the Fed announced it would cut those holdings by about $35 billion a month, starting this month. If it decides to further reduce its participation, it would reduce the demand for mortgage securities, which, through the internal logic of the credit markets, would lead to higher interest rates.

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