It’s bad enough that home prices in Southern California remain high despite cold demand, averaging nearly seven times the state’s median income for a family of four.
To make matters worse, the rapid rise in mortgage interest rates. The 30-year fixed-rate mortgage rate doubled in nine months, reaching 6% last week for the first time since the presidency of George W. Bush.
This hurts not only for people trying to borrow money to buy a home, but also homeowners with an adjustable mortgage, whose monthly payments go up every year as interest rates go up.
Two factors driving the increase were inflation and the Federal Reserve’s efforts to tame it. The Federal Reserve has raised the rate for short-term “federal funds” (the interest that banks charge each other for overnight loans) five times this year, including on Wednesday.
The key factor in mortgage interest rates is how much inflation lenders expect to see over the life of the loan, said David Wilcox, chief economist at the Peterson Institute for International Economics and at Bloomberg Economics. Given the messaging from the Federal Reserve and continuing inflationary pressures in the economy, financial markets expect a higher trajectory for interest rates in the coming years than they did earlier in 2022.
So do you expect to pay more for a new mortgage now that the Fed has imposed its latest increase? Perhaps, 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 since 1980: Mortgage rates fell. They started to climb again a few weeks later in anticipation of the Federal Reserve’s meeting in July, when it raised its target by 0.75 percentage points for the second time. After that, mortgage interest rates fell again.
This shows how financial markets are ahead of the Fed, reacting to expectations rather than waiting for the central bank to act. When the Fed meets those expectations, “you usually see some kind of comfortable recovery,” said Robert Heck, vice president of mortgages at Morty, an online mortgage broker.
The Fed is trying to break the inflationary fever of the economy without pushing the country into recession, but the usual indicators of economic health are confusingly mixed. GDP is declining, but unemployment remains low; Corporate earnings are substantially strong; Consumer confidence is recovering; Consumer spending continues to grow, albeit slowly.
Federal Reserve Chairman Jerome H. Powell has repeatedly said that the Fed will raise interest rates until inflation is under control. However, Heck said some lenders and investors looked at the economy in July and thought the Fed would take its foot off the monetary brake.
But that changed in August, when Powell and other Fed officials confirmed their intention, as Powell said on August 26, to “keep on doing so until we make sure the job is done.” Intentionally or unintentionally, the statement echoed the title of the memoirs of former Federal Reserve Chairman Paul Volcker, who used high interest rates to pull the United States out of double-digit inflation in the 1980s.
“I think the Fed has managed to communicate more clearly, and the market has taken more, more broadly, its determination to fight inflation and win the battle,” Wilcox said.
At the same time, Wilcox said, “the market has concluded that the Fed will have to do more to win that battle.”
He said recent data shows inflation is broader and more stubborn than previously thought, and that the labor market remains “extraordinarily strong”.
Heck said none of the newly released economic data had indicated lower interest rates.
Hence the steady rise in mortgage interest rates since early August.
Another reason for the increase, Heck said, is speculation that the Federal Reserve may raise the federal funds rate by a larger amount on Wednesday – from 1 to 1.25 percentage points. “I think this meeting is probably the one we’ve been least prepared for, in terms of knowing what’s going to happen,” Heck said. But the Fed met expectations on Wednesday, not guesswork.
One key to the market’s reaction will be the “dot chart,” or the graph that shows how far Fed officials expect the federal funds rate to go up or down in the next few years. Powell said he expects the federal funds rate to reach 3.4% by the end of this year. After Wednesday’s action, most Fed officials expect the federal funds rate to reach a range of 4.25% to 4.5%. (As the Wednesday meeting began, the rate was in the 2.25% to 2.5% range.)
Another important consideration, Heck said, is what Fed officials have said about the central bank’s holdings of mortgage-backed securities. Earlier in the year, the Fed announced that it would reduce these holdings by about $35 billion per month, starting this month. The Fed signaled on Wednesday that it would stick to that plan. Shrinking her holdings could have led to higher interest rates by the internal logic of credit markets.
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