How the Economy Impacts Mortgage Rates

How the Economy Impacts Mortgage Rates

As someone considering buying or selling a home, you’re likely paying close attention to mortgage rates and wondering what’s ahead.

One factor that can influence mortgage rates is the Federal Funds Rate, which affects how much it costs banks to borrow money from each other. While the Federal Reserve (the Fed) doesn’t directly control mortgage rates, they do control the Federal Funds Rate.

The connection between the two is why many people are watching to see when the Fed might lower the Federal Funds Rate. When they do, it will likely put downward pressure on mortgage rates. The Fed meets next week, and three key metrics they’ll consider in their decision are:

1. The Rate of Inflation
2. How Many Jobs the Economy Is Adding
3. The Unemployment Rate

Here’s the latest data on all three.

1. The Rate of Inflation

You’ve probably heard a lot about inflation over the past year or two—and you've likely felt its impact whenever you've gone shopping. High inflation means prices have been rising quickly.

The Fed's goal is to reduce the rate of inflation to 2%. While it's still higher than that, it's moving in the right direction (see graph below):

2. How Many Jobs the Economy Is Adding

The Fed is also monitoring the number of new jobs created each month. They want to see job growth slow down consistently before making any changes to the Federal Funds Rate. If fewer jobs are created, it indicates the economy is still strong but cooling down slightly, which is their goal. That appears to be exactly what’s happening now. Inman says:

“. . . the Bureau of Labor Statistics reported that employers added fewer jobs in April and May than previously thought and that hiring by private companies was sluggish in June.”

So, while employers are still adding jobs, they’re not adding as many as before. That’s an indicator the economy is slowing down after being overheated for quite some time. This is an encouraging trend for the Fed to see.

3. The Unemployment Rate

The unemployment rate represents the percentage of people who want to work but can’t find jobs. A low unemployment rate indicates that many Americans are employed, which is positive for the economy.

However, a low unemployment rate can also contribute to higher inflation because more people working means more spending, which drives up prices. Currently, the unemployment rate is low but has been gradually rising over the past few months (see graph below):

It may seem harsh, but a consistently rising unemployment rate is something the Fed needs to see before deciding to cut the Federal Funds Rate. A higher unemployment rate would mean reduced spending, which would help bring inflation back under control.

What Does This Mean Moving Forward?

While mortgage rates are likely to remain volatile in the coming days and months, these indicators suggest the economy is moving in the direction the Fed wants to see. However, it's unlikely that the Fed will cut the Federal Funds Rate when they meet next week. Jerome Powell, Chair of the Federal Reserve, recently said:

“We want to be more confident that inflation is moving sustainably down toward 2% before we start the process of reducing or loosening policy.”

Basically, we’re seeing the first signs of progress now, but the Fed needs more data and more time to be confident that this is a consistent trend. Assuming this direction continues, according to the CME FedWatch Tool, experts project a 96.1% chance the Fed will lower the Federal Funds Rate at their September meeting.

Remember, the Fed doesn’t directly set mortgage rates. However, whenever they decide to cut the Federal Funds Rate, mortgage rates typically respond.

Of course, the timing of the Fed's actions could change due to new economic reports, world events, and other factors. That’s why it's usually not a good idea to try to time the market.

Bottom Line

Recent economic data may signal that hope is on the horizon for mortgage rates. Let’s connect so you have an expert to keep you updated on the latest trends and what they mean for you.