In the just-released FOMC statement, the Fed announced a 0.50% (50 basis points, or bps) cut to the Fed funds rate. There was debate in the press and in the market that a smaller 25bps cut was called for. This 50bps cut, projected to begin a cycle of cuts, was less in keeping with the market consensus and raises concern about what the Fed knows about current conditions that justifies this larger cut. This cut moves the Fed funds range down to 4.75% to 5.00% and is the first Fed funds monetary policy rate action taken in the past nine FOMC meetings, dating back 14 months to July 2023.
Also just released is the latest re-fresh of the Fed members’ “dot plot” projections. Each member projects a series of economic measures known as the dot plots. From those a consensus can be determined as an indication of the Fed’s latest future jobs and economic projections and the monetary policy actions they expect to take.
The projection receiving primary attention is the Fed Funds rate. Monetary policy puts the level of the Fed funds rate in the FOMC’s hands to manage as one of the tools to achieve the Fed’s dual mandates to pursue maximum employment and price stability. Fed funds rate influences but does not set term rates such as mortgage rates. Depending on the loan program, those are set in the marketplace for MBS securities, private label securities, or by investor portfolio demands. But the influence the Fed carries does factor significantly in each of those arenas.
The dot plot projections give an important opportunity to see how future monetary policy actions are evolving within the FOMC. The future pace of rate cuts that started with today’s rate cut and the expected terminal rate of this rate cut cycle, which are in today’s consensus dot plots, are equally as important to today’s market reaction as the rate cut itself.
The Fed guidance the market is looking for today will come from the cut itself (50bps, not 25bps), the policy statement, the dot plots, and comments from Chair Powell.
- Listen to Powell’s press conference for the reasoning behind cutting 50bps and not 25bps.
- Watch for policy statement changes that project the pace of future rate cuts.
- Watch for Fed funds dot plot changes indicating an increase in the number of rate cuts or an acceleration in the timing of those cuts. Comparing today’s dot plot to the June dot plots, the market will look to see how much faster the Fed is projecting to move, and if the terminal rate is set lower.
- At the last dot plot update in June, policymakers projected Fed funds to be reduced to 4.125% by year-end 2025.
- The current futures market projection is pricing in 4.1% by the end of 2024.
That’s a big difference between monetary policymakers and the market. While these different outlooks evolve, we can expect elevated volatility. With today’s larger 50bps cut, this the market is likely to react strongly to this.
- Is the terminal rate in today’s dot plots lower than the previous projection of 2.8% and reached in 2025, not 2026? If so, is the Fed expecting a recession now, seeing the need to make monetary policy accommodative?
- Finally, Fed Chairman Powell’s press conference is expected to focus on the same rate cut size and timing scrutiny the dot plots will come under. He will be questioned on what factors drove the FOMC to make a 50bps cut. Is the economy heading towards a recession and not the desired soft landing?
What’s Next?
With the beginning of this cycle of rate cuts accomplished, investors’ immediate focus is on the near-horizon timing of additional rate cuts, the terminal rate of this cycle of cuts, and when the Fed thinks that will be reached. With the next meeting coming after the Presidential election, avoiding the appearance of political influence comes off the table. That likely adds pressure for another 50bps cut at the November 7 FOMC meeting.
The complicating matters of geopolitical risks associated with the wars in Europe and the Middle East, global economic developments and associated foreign central bank policy actions, and an eventual increase in the size of U.S. Treasury financing auctions remain. The Treasury is indicating it will be several more quarters before they expect to materially increase auction sizes, but that is coming and plays into not only the general level of interest rates, but also the relative posture of elevated short-term rates to longer-term rates, where fixed mortgage rates are sponsored.
Until the November Fed meeting, there will be new readings on employment and inflation data for markets to consider. That gives some time for the market and policymakers to adjust to each other’s projections once the initial reactions to today’s events are priced in.
The takeaway from the present situation is twofold — yes, mortgage rates will likely trend lower as the Fed continues this cycle of rate cuts. But 30-year fixed mortgage rates price off the term range of the yield curve, not the front end that Fed policymakers have any control over. That leaves the market and its expectations driving the bulk of mortgage rates we operate with. And today has price confirmed the reaction to the Fed’s policy decision to begin this cycle of cuts, and at the pace of those cuts, at least until new data forces further course corrections.
Second, the current level of volatility — a short-term phenomenon (think typical rate lock period) — will mean the path lower is not a smooth decline. Potential borrowers will hear rates are declining, but in the immediate timing of closing a transaction, they may face rates that are increasing or at least above the level they expected.
What Do Borrowers Do Now?
Originators should explain to borrowers looking to finance the purchase of a home that even as rates are expected to fall over time, the current mortgage rate market remains exposed to greater-than-typical levels of uncertainty that could lead to higher rates within typical rate lock periods.
The available housing inventory remains tight and will remain so for years to come. After finding a home for purchase and achieving an accepted offer, the best course of action is to secure financing quickly to avoid the worst of possible market volatility that could upend those plans.
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