Why Fed Cuts Don’t Always Bring Mortgage Rates Down (Full Transcript)

[00:00:00] Speaker 1: In 2020, the Federal Reserve lowered interest rates, and mortgage rates followed. Then later, to deal with inflation, the Fed raised interest rates. And again, mortgages followed. So now, Trump wants the Fed to do it again, in hopes that the same thing will happen.

[00:00:15] Speaker 2: We're keeping the rates high, and it's hurting people from buying houses, and we don't want that. But it's not a sure bet.

[00:00:22] Speaker 1: Even when the Fed did cut interest rates in September of 2024, mortgages didn't go down. So why don't Fed rate cuts necessarily help your mortgage?

[00:00:34] Speaker 3: The Fed is arguably the most powerful institution in the world economy. And so that one number, right, the interest rate that the Fed sets, it really sets the tone for the entire U.S. economy.

[00:00:50] Speaker 1: That one number is this one, the federal funds rate, which is the interest rate banks use to lend each other money overnight.

[00:00:57] Speaker 4: Why would a bank need to borrow money? The bank doesn't like to store all your money in its vault. If it did, there's no way of it making money.

[00:01:03] Speaker 1: Justin Wolfers, an economist at the University of Michigan, says the bank lends some of your money out to other people, for things like credit cards, personal loans, and car loans. But then, if you need that money back, and the bank is short by this much, it can make up the difference by borrowing from other banks.

[00:01:20] Speaker 4: The other bank will say, well sure, but I want some interest if I'm going to lend it to you. What the Federal Reserve does is it walks into that market and it says, tell you what, just come and borrow from me instead. And it says, here's the interest rate I'm going to charge, three percent. Well, if the Federal Reserve is willing to loan money at a rate of three percent, no one will borrow from anyone else at a rate higher than three percent.

[00:01:40] Speaker 1: So the federal funds rate is just a little lower than the rate the Fed offers. This is how much the Fed has offered in the past two years. And here's the federal funds rate just below it. The central bank also sets a floor to keep the federal funds rate within a range. When the Fed raises or lowers that range, it's often by as little as a quarter of a point. But those tiny changes can be felt throughout the economy.

[00:02:04] Speaker 4: You might not think that the interest rate is all that important, that we economists sure do. When interest rates are high, borrowing a lot of money to build a house doesn't make a lot of sense because you'll have to pay a lot back. People buy fewer houses for the same reason we buy fewer cars and we buy fewer refrigerators.

[00:02:22] Speaker 1: But a lot has to happen before the federal funds rate can ripple out to mortgages, and even beyond. Since banks borrow at the federal funds rate, they'll always lend out at a higher rate than that. Banks add three percent to the federal funds rate to establish the prime rate.

[00:02:38] Speaker 3: It's what they charge to their best borrowers, the ones with the strongest history of borrowing.

[00:02:44] Speaker 1: Now, the prime rate plays a big part in the rate you get on car loans, personal loans, and credit cards. But it's not the only factor.

[00:02:52] Speaker 3: They're going to look at everything from that person's employment history, their credit history, their credit score. They want to know what it is that they're borrowing to buy.

[00:03:02] Speaker 1: When you compare these loans, they're all closely correlated to the prime rate. But check out mortgages. They're also correlated to the prime rate, but with a bit more variance. The federal funds rate started to go down in September of 2024, and so did the prime rate, as did credit cards and personal loans. But remember, mortgage rates didn't, because they include an additional factor, the 10-year treasury bond. You can see that mortgages follow the 10-year treasury bond much closer than the prime rate. And that's because mortgages and 10-year bonds are pretty similar. When you buy a 10-year bond from the U.S. Treasury, it pays you a fixed interest rate over its entire duration, just like how you pay a fixed rate on your mortgage over 30 years. But here's the thing. Even though it's called a 30-year mortgage, most people keep a mortgage for only 10 years, which is why they follow 10-year treasury bonds. And the rate that a 10-year bond pays is determined by a market, and it looks at the federal funds rate today and what it thinks will happen to it in the future. If the bond market believes the federal funds rate will go up, it will demand a higher rate. And it also looks at other factors.

[00:04:08] Speaker 3: They're thinking about government spending over the next 10 years, government borrowing over the 10 years, how vast the economy is projected to grow, and how safe U.S. institutions are, how stable the economy is before they decide how much they want to lend to the U.S. government.

[00:04:28] Speaker 1: The long-term view of the 10-year bond means it can move in a different direction to the federal funds rate, which is based on the short term.

[00:04:35] Speaker 3: In a lot of ways, the bond market has a veto over the Fed. And what I mean by that is if bond market investors, they don't trust that the Fed is going to actually get inflation under control, then they can rebel by causing interest rates in the bond market to go even higher. So that's why it's really important that the Fed means what they say when they promise to get inflation under control, because if they don't, then it can completely backfire because of the power of the bond market.

[00:05:07] Speaker 1: But the Fed doesn't believe it's to blame for the divergence in the federal funds rate and the 10-year treasury bonds.

[00:05:13] Speaker 5: Surveys are all saying that the public understands our commitment to 2% and expects us to get back there. So why are rates going up? It has to be something else. It must be an expectation of higher growth or something like that.

[00:05:28] Speaker 1: The Fed can only control monetary policy in the here and now. If Trump wants mortgages to come down, the bond market has to trust his long-term fiscal policy.