The start of a new year often inspires reflections on the past, with renewed effort to apply any lessons we've learned to try to anticipate
Calling the Plays: How the Fed Quarterbacks Mortgage Rates
Published Date : January 29, 2025
The U.S. economy spent most of 2024 with short-term interest rates stuck at around 5.3%. Then, in September, the Fed finally began lowering rates just as football season kicked off (better luck next year to my teams, the Georgia Bulldogs and the San Francisco 49ers). As fall turned to winter, the Fed had delivered 100 basis points of rate cuts—but despite this easing in monetary policy, mortgage rates instead went up, not down. This surprised a lot of people who thought that lower Fed rates would usher in relief on the mortgage front. In some ways, I think the relationship between the Fed and mortgage rates is a little like a football team in action: The Fed’s decisions act as the quarterback, setting the play in motion by signaling shifts in monetary policy; however, mortgage rates, like the rest of the team, don’t always move in perfect sync or respond immediately.
Indeed, the Fed’s actions can only indirectly influence mortgage rates, but it doesn’t set them per se. The only rate that the Fed directly sets is the target for short-term overnight rates, called the Fed Funds Rate. However, mortgages are more closely tied to the 10-year Treasury, which acts as the primary benchmark for many longer-term loans. Leading up to the first rate cut in September, rates on both the 10-yr Treasury and 30-year fixed rate mortgage declined as inflation improved and markets anticipated a significant number of additional rate cuts coming in 2025. By late September, both the 10-yr Treasury and 30-year mortgage reached their 2024 lows of 3.63% and 6.08%, respectively. Then, in the fourth quarter, expectations for 2025 shifted and markets began pricing in stickier inflation, more fiscal spending, and fewer 2025 Fed rate cuts following the outcome of the U.S. presidential election. In turn, this change in expectations caused the 10-yr Treasury to rise 95 basis points into year-end even though the Fed Funds Rate decreased 100 basis points. Commensurately, mortgage rates rose as well and ended the year at 6.85%.
The current spread between 10-year Treasury yields and mortgage rates remains historically wide, a divergence largely driven by elevated interest rate volatility. When volatility is high, investors demand a higher risk premium, contributing to the wider spread. Supply and demand dynamics also play a crucial role. During 2020–2021, the Fed and banks purchased substantial quantities of mortgage-backed securities, driving mortgage rates sharply lower. However, as monetary policy shifted and these institutions reduced their holdings, mortgage rates climbed, and spreads widened. Beyond these macroeconomic and policy-driven factors, several other borrower-specific elements also influence mortgage rates, such as creditworthiness, property type, and down payment size.
Like a football quarterback, sometimes the Fed will signal a deep pass by changing their forecast for rate cuts, and receivers—or “mortgage rates”—are forced to adjust their route. Timing and execution aren’t always perfect though. Despite lower short-term rates, longer-term mortgage rates have remained stubbornly high. The “play” forward will largely depend on inflation and broader economic trends. While many forecasters anticipate mortgage rates to remain in the mid-6% range throughout the year, uncertainty has increased as we await potential policy changes from the new administration. While mortgage rates often take their cue from the Fed, they can hesitate, change course, or even run in a different direction from time to time. Continuing to watch the broader field, including inflation trends and economic growth, can provide valuable insights into where mortgage rates might head next.
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