Why Aren't Mortgage Rates Falling?

Many in the real estate and mortgage industry expected a ticker-tape parade for Jerome Powell back on September 18th, when the Federal Open Market Committee officially lowered the Federal Funds rate by 0.5%. They also signaled that further reductions in the Federal Funds rate are coming.

So why didn’t mortgage rates drop? In fact, rates are a little higher now at the beginning of October than they were on the day Powell made his announcement.

(As an aside, I reached out to some fellow authors who write for publications like CNN and MBS Highway, letting them know that their reporting on rates dropping after the announcement was based on old data—released after the announcement but reflecting earlier conditions. It's kinda like reporting a sale at the grocery store by looking at the Sunday coupon section from two weeks ago).

Most folks (including myself) believe that rate relief is coming. The National Association of Realtors, federal mortgage agencies like Freddie Mac and Fannie Mae, and big banks like Wells Fargo and Bank of America all forecast that we’ll see mortgage rates fall by 0.5% to 0.75% within the next six months.

So why hasn’t it happened already? I see three reasons:

1.???? Ding, dong, the inflation witch is dead—right? The water has been poured on her, but we haven’t seen her melt to the ground quite yet. The rate of inflation has fallen for six straight months, but we're still well above pre-COVID levels. Inflation remains a factor in the Federal Reserve’s attempt to achieve a ‘soft landing,’ which is why the Federal Funds rate didn’t drop more in September.

2.???? The U.S. Treasury bond market rate of return and the rate of inflation are correlated—which kinda makes sense. A U.S. Treasury bond is (allegedly) one of the most secure investment available to buy (meaning that the U.S. government is unlikely to default on the bonds it issues). If inflation rises, the rate of return on those bonds must rise to attract buyers.

3.???? Here is the main event, on why I believe rates aren’t falling faster… The Federal Reserve is competing against itself in the bond market. The Fed obviously sells Treasury bonds, but few realize they also own about $2.28 trillion worth of mortgages—which roughly 7 million individual mortgages. Yup, that’s right. A mortgage just like yours or mine could be owned by the Federal Reserve. They buy mortgages to give money back to banks, allowing them to continue lending. However, since early 2022, the Federal Reserve has been slowly but surely selling more these mortgages off their books.

The Mortgage-Backed Securities market and the Treasury market have always competed for trillions of dollars in low-risk investments.

The Fed has sold off roughly 1.5 million homes' worth of bonds into the open market over the past 18 months (see below, it appears they have no plans to stop either). Thus, they are essentially competing with themselves in the Treasury market for buyers. This competition drives demand for a higher rate of return (each seller of the bond must make their bond look like the ‘prettiest girl at the dance’, which in this case is a higher rate of return). Ultimately, if a buyer of a Mortgage-Backed Security wants a higher rate of return, this trickles back to what a new homebuyer or someone refinancing will be offered as a mortgage rate.

Conclusion: To see mortgage rates really start to drop, we need inflation to continue cooling and for someone to declare the ‘war on inflation’ over. We also need the Federal Reserve to ease up on selling off its mortgage holdings in the open market.

The good news is that it’s likely we’ll see both of these occur within the next 6 to 18 months. Albeit, the Mortgage Backed Securities selloff trend may last longer.