Mortgage Predictions: New Inflation Data Cements a Fed Cut Next Week

1 week ago 4

Average mortgage rates surged to around 7% last month, but they've dropped recently, with markets betting that the Federal Reserve will reduce the federal funds rate on Dec. 18.

Two data points are key for the Fed to cut interest rates by 0.25% next week at its final policy meeting of the year: slowing inflation and a weakening labor market. While Wednesday's Consumer Price Index report shows inflation rose 2.7% in November, it was in line with investor expectations. Last week's employment data showed a strong job market, but not overly so.

Another rate cut doesn't mean mortgage rates will immediately move lower. The central bank has cut interest rates twice already this year, and mortgage rates went up, not down, due to a continuation of strong economic data. Though influenced by the Fed's actions, home loan rates are more closely tied to movement in the bond market.

Mortgage rates could still fall if economic data weakens and the Fed continues cutting interest rates. But that's a big "if."

Lately, progress has stalled on getting inflation down to the Fed's 2% annual target. Meanwhile, the labor market isn't showing any major fault lines. While the Fed wants to avoid keeping borrowing rates too high -- which could tip the economy into a recession -- it's also wary of cutting interest rates too quickly only to see inflation reheat.

There's also the issue of President-elect Donald Trump's economic policies and whether his plans to issue sweeping tariffs and tax cuts will fuel inflation.

According to Sam Williamson, senior economist at First American Financial Corporation, the Fed's decision to reduce interest rates next week won't be based on future projections for the new administration. However, if the White House implements policies that prove to be inflationary down the road, the Fed will consider all options in 2025, including hiking interest rates, said Williamson.

That's not good news for the housing market or for would-be homebuyers, who have been sidelined by a combination of soaring mortgage rates, rising home prices and limited supply.

How does economic data drive mortgage rate movement?

Inflation and labor data act as a barometer for the health of the economy and influence the Fed's decision to adjust its benchmark short-term interest rate up or down. The central bank has two main objectives: maintain maximum employment and contain inflation.

When inflation was at its peak in 2022, the Fed raised interest rates to lower demand and limit price growth. The Fed pivoted to cutting interest rates earlier this fall, as data pointed to cooling inflation and a slower job market.

Bond market investors also rely on economic data to anticipate future Fed policy moves, and mortgage rates take direction from bond yields, said Melissa Cohn, regional vice president at William Raveis Mortgage.

For instance, bond yields and mortgage rates fell significantly ahead of the Fed's Sept. 18 rate cut but quickly rebounded in response to a strong labor report in early October.

Home loan rates are often quick to rise but slow to fall. For instance, it can take a few soft economic reports for mortgage rates to move lower, but just one strong piece of data to send them higher.

Are mortgage rates high because of the election?

It's not a coincidence that mortgage rates have increased significantly since the results of the election were confirmed early last month.

In October, markets started defensively "pricing in" a Trump victory, which reversed many of the mortgage declines seen through the end of the summer.

"Right now, there's upward pressure on mortgage rates because of fears of rising debt and deficit levels and an acknowledgment that the incoming Trump administration could help grow the economy," said Ali Wolf, chief economist at Zonda, a home construction data company.

Fed Chair Powell has said it's too early to say how Trump's policies and a Republican-led Congress might alter the central bank's approach to interest rate adjustments.

What is the outlook for mortgage rates in 2025?

While a rate cut next week is all but guaranteed, it could be just temporary relief.

"I do expect a cut in December and then a wait-and-see approach from there," said Greg Sher, managing director at NFM Lending.

With inflation still above target and job growth strong, bond market investors now expect fewer Fed rate cuts and higher long-term interest rates, which is likely to keep upward pressure on mortgage rates.

Although experts optimistically called for rates to fall close to 6% by the end of 2024, that's less of a possibility. Fannie Mae now expects average 30-year fixed mortgage rates to hold above 6.5% until early 2025.

"If the economy continues to remain on solid footing, then it is likely that we will see little downward movement in mortgage rates," said Cohn.

In other words, rates will only go down in 2025 if the economy weakens. That means housing affordability won't change much in the short term.

What else is happening in the housing market?

Today's unaffordable housing market results from high mortgage rates, a long-standing housing shortage, expensive home prices and a loss of purchasing power due to inflation.

🏠 Low housing inventory: A balanced housing market typically has five to six months of supply. Most markets today average around half that amount. Although we saw a surge in new construction in 2022, according to Zillow, we still have a shortage of around 4.5 million homes.

🏠 Elevated mortgage rates: At the start of 2022, mortgage rates were near historic lows of around 3%. As inflation surged and the Fed began hiking interest rates to tame it, mortgage rates roughly doubled within a year. In 2024, mortgage rates are still high, effectively pricing millions of prospective buyers out of the housing market. That's caused home sales to slow, even during typically busy home-buying months, like the spring and early summer.

🏠 Rate-lock effect: Since the majority of homeowners are locked into mortgage rates below 6%, with some as low as 2% and 3%, they're reluctant to sell their current homes since it would mean buying a new home with a significantly higher mortgage rate. Until mortgage rates fall below 6%, homeowners have little incentive to list their homes for sale, leaving a dearth of resale inventory.

🏠 High home prices: Although home buying demand has been limited in recent years, home prices remain high because of a lack of inventory. The median US home price was $434,568 in September, up 5.1% on an annual basis, according to Redfin.

🏠 Steep inflation: Inflation increases the cost of basic goods and services, reducing our purchasing power. It also impacts mortgage rates: When inflation is high, lenders typically set interest rates on consumer loans to compensate for the loss of purchasing power and ensure a profit.

Expert advice for homebuyers

It's never a good idea to rush into buying a home without knowing what you can afford, so establish a clear homebuying budget. Here's what experts recommend before purchasing a home:

💰 Build your credit score. Your credit score is one of the main factors lenders consider when determining whether you qualify for a mortgage and at what interest rate. Working toward a credit score of 740 or higher will help you qualify for a lower rate.

💰 Save for a bigger down payment. A larger down payment will allow you to take out a smaller mortgage and get a lower interest rate from your lender. If you can afford it, making a down payment of at least 20% will also eliminate the need for private mortgage insurance.

💰 Shop around for mortgage lenders. Comparing loan offers from multiple mortgage lenders can help you negotiate a better rate. Experts recommend you get at least two to three loan estimates from different lenders before making a decision.

💰 Consider the rent vs. buy equation. Choosing to rent or buy a home isn't just comparing monthly rent to a mortgage payment. Renting offers flexibility and lower upfront costs, but buying allows you to build wealth and have more control over your housing costs. The best choice depends on your finances, lifestyle and how long you plan to stay in one place.

💰 Consider mortgage points. One way to get a lower mortgage rate is to buy it down using mortgage points. One mortgage point equals a 0.25% decrease in your mortgage rate. Generally, each point will cost 1% of the total loan amount.