Federal Reserve

The Fed Wants Lower Mortgage Rates

Casey Fleming

The Fed wants lower interest rates. What? You heard just the opposite? No, you just think you heard the opposite. They raised the discount rate, which immediately brought mortgage rates down across the board.

I’m using shock value, of course, but it’s true: The Fed wants lower mortgage rates, or at least the economic conditions that make that happen. As I have written before, the Fed doesn’t directly control mortgage rates. The three most important factors in mortgage rates are inflation, inflation and inflation. The higher inflation goes, the higher long-term interest rates, like mortgage rates, must go too. What happened Wednesday is that the Fed signaled that it was getting inflation under control. Wait, what?

So How is Inflation Doing? Isn’t it Still High?

Mortgage rates rose as investors fretted about inflation. But now?
Investor fret about inflation

According to the Bureau of Labor Statistics—the folks who track the Consumer Price Index—prices rose from December of 2021 through December of 2022 by 6.5%. That sounds like it’s still pretty high, right? That tends to be the “headline” reading that most media reports. But inflation wasn’t much of an issue until late 2021, and the Fed only started to try to control inflation in 2022. Why would smart folks believe that inflation is coming down?

Since the Fed has been working on controlling inflation over the course of last year, let’s take a look at the last few months to see if they’ve made any progress.

In July 2022, the prices for all item categories rose 0% from the month of June. Wait. 0? Yes, 0%. Well, some items rose but energy, gasoline and fuel oil dropped quite a bit, evening out the prices for a basket of items.

In August, prices rose 0.1%, an annualized inflation rate of 1.2%. Still surprised? Energy and gasoline continued to drop notably this month.

In September, prices rose 0.4%, for an annualized rate of 4.8%.  Energy-related items still fell but not by so much, and other commodities, like food, continued to rise.

In October prices rose another 0.4%, again an annualized rate of 4.8%. While some categories declined, there was a big spike in energy-related commodities—right when the weather was getting cold, of course.

In November, prices for all items rose 0.1% – back down from October highs. Energy prices were essentially flat, with increases in prices for other categories beginning to stabilize.

In December prices fell 0.1%. as most categories stabilized and energy-related items took another fall from November prices.

Doing some simple math, prices for all items rose from June through December of 2022 by 0.55%, for an annualized rate of 1.1%. Once you dig past the headlines, it doesn’t seem so bad, does it?

But the Fed doesn’t look only at backward-looking data—they consider forward-looking data, such as employment reports, unemployment claims, job openings, wage growth and consumer confidence. How are those indicators doing?

This week we discovered that:

Job growth January 2023
Companies are still hiring
  • The ADP employment report counted 106,000 new jobs created in December, down from 253,000 in November, and less than the 190,000 expected by analysts.
  • Non-farm payrolls, however, has a massive increase of 517,000 new jobs, likely due to seasonal hiring.
  • Unemployment claims fell very slightly to 185,000, about an average number.
  • Job openings unexpectedly rose 10.4 mm to 11.0 mm.
  • The employment cost index (a measure of wages) was flat, down from an annualized growth rate of 1.2% in November.
  • Consumer confidence was down from December and worse than expected by analysts, but still in positive territory.

Taken in concert, and in light of the CPI readings, it really does appear that we are making great progress fighting inflation. (But perhaps still have more to do.)

When I say that the Fed wants lower mortgage rates, what I am really saying is that they want lower inflation. But that always leads to lower mortgage rates.

Why Does Inflation Matter to Mortgage Rates?

As I’ve written before, institutional investors who invest in long-term debt (like mortgages) care mostly about inflation—they must earn more than what they believe inflation will be over the life of their investment. These investors move hundreds of millions of dollars every day from one investment to another. They are smart folks, and they know more than I do. Because they’ve been accepting lower and lower yields since early November, they clearly believe inflation will continue to moderate.

The Fed Raises Rates to Fight Inflation, Though, Right?

Yes, exactly. During the early part of 2022, investors were concerned about long-term inflation. The Fed’s move to raise short-term rates to cool the economy were welcomed, but the CPI was rising rapidly and forward-looking data was not indicating that inflation would ease soon. Investors had to demand a higher yield on their investments, translating to higher mortgage rates. Result: When the Fed raised rates through most of 2022, they explained that inflation was still not under control and more aggressive rate hikes would be necessary. So, mortgage rates rose when the Fed raised short-term rates and then commented.

Once inflation began to moderate, however, (see the first part of this article) the Fed had a different message: “We think we’re making headway,”  we don’t want investors to believe that we aren’t serious about fighting inflation, though, so “we will continue to raise short-term rates as much as necessary.” (Italicized portion was never spoken out loud, but understood.)

So, in early November when the Fed raised short-term rates again—despite clearly friendlier CPI news—mortgage rates began to improve rather than worsen. In mid-December the Fed took two actions (as I predicted) that reassured investors. They raised short-term rates, but only by 0.50%, rather than the 0.75% earlier bumps, and said they were clearly making progress but still committed. Mortgage rates improved further, but came back up slightly over the holidays.

Now, in February, the Fed again raised short-term rates (but again at an even slower pace than before, down now to 0.25%) and said they were confident that inflation was coming under control, but would raise rates again if new data suggested it was necessary. Because the Fed wants lower mortgage rates!

It’s Not Past Data That Matters, but Current Data and Future Expectations

Looking to the Future
Investors look forward, not back Photo by Braldey Hook via Pexels

This is the lesson if you want to understand where mortgage rates will go. All that matters is inflation, inflation and inflation—or, more accurately, the expectation of investors in mortgage-backed securities about where inflation will go in the next ten years or so.

Forget the headlines and especially the click-bait. Watch for mortgage interest rates to decline in the next week or two, and continue a slow, unsteady decline over the course of the year. Once inflation has settled in the 2% to 3% range for an extended period of time, mortgage rates should settle back down to the mid-4% range, with some days better.

If I’m right, you read it here first. If I’m wrong, I’ll deny everything.


Casey Fleming, Author The Loan Guide (2014) and Buying and Financing Your New Home, 2023

Sources used in this article:

Consumer Price Index Summary

About Casey Fleming: Casey Fleming is a veteran mortgage advisor (NMLS 344375) and Author of The Loan Guide and Buying and FinancingYour New Home writes extensively about real estate finance, the real estate market, and the relationship between economics and finance. He advises clients throughout California, and is based in the heart of Silicon Valley.  He writes articles regularly for several online publications, is a subject-matter expert for two prominent finance-related sites, and is regularly quoted in articles for many other publications.

This article represents the opinions of Casey Fleming, and not necessarily those of any company or organization cited or mentioned in this web site.  This analysis was prepared with the best information available at the time it was written.  We do not have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source.  No warranty is made that the outcome will reflect the projections in this article, and neither the author nor LoanGuide.com are responsible for decisions that you make regarding your choices about your real estate or mortgage or those of your clients.

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