Bond market investors are focused on the “rich dot,” indicating that Fed policymakers only expect to lower short-term rates by half a percentage point in 2025.
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Federal Reserve policymakers approved their third rate cut of the year on Wednesday but set a more conservative path to future cuts that have sent long-term loan rates spiraling into inflationary pressures.
A vote to cut the short-term federal funds rate by a quarter percent was expected, although Cleveland Fed President Beth Hammack voted against it.
More importantly for investors in bond markets that fund mortgages, the latest “dot plot” showing how each Fed policymaker expects short-term rates to hold in the coming years shows little enthusiasm for a rate cut in 2025.
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“With today’s action, we have lowered our policy rate by a full percentage point from its peak and our policy stance is now much weaker,” Federal Reserve Chairman Jerome Powell told reporters after the vote. “So we can be very cautious as we consider further changes to our policy measures.”
The yield on 10-year Treasury notes, a measure that measures mortgage rates, rose 11 basis points as Powell told reporters.
An index compiled by Mortgage News Daily showed 30-year mortgage rates rising 21 basis points on Wednesday, to 7.13 percent.
Rates on the 30-year fixed-rate mortgage due 2024 fell to 6.03 percent on Sept. 17 on expectations of a Fed rate cut, according to lock-in data tracked by Optimal Blue. But once the Fed started cutting, mortgage rates rebounded to a fourth-quarter high of 6.85 percent on November 20.
Mike Fratantoni
“Expectations that the Fed will cut rates below market expectations have been fueled by the high 10-year Treasury yield and higher mortgage rates in recent weeks,” said Mortgage Bankers Association Chief Economist Mike Fratantoni in a statement.
The MBA’s forecast for mortgage rates “increased after the election, anticipating this change and seeing the market’s reaction to the possible path of monetary policy and the deficit,” Fratantoni said.
MBA economists predict that mortgage rates will reach 6.5 percent over the next few years, with “significant volatility in that rate.”
Fed ‘dot plot’ suggests cautious approach
Source: Federal Open Market Committee Dec. 18, 2024, Summary of Economic Projections
Most members of the Federal Open Market committee expect that by the end of next year, the target for the federal funds rate will be between 3.75 percent and 4 percent – just half a percentage point lower than the current rate.
“The low rate of reduction next year really reflects both the high inflation figures we’ve had this year and the expected inflation to be higher,” Powell said.
The latest dot plot also shows Fed policymakers expect to cut rates by half a point again in 2026.
While Fed policymakers see high risks and uncertainty about inflation, “we see ourselves on a path to continue cutting,” Powell said. “I think the real cuts we’re going to make next year won’t be because of anything we wrote down today. We will respond to the data.”
Fed cuts rates from 2-decade highs
After cutting short-term interest rates to zero during the pandemic to keep the economy from collapsing, Fed policymakers voted to fight inflation, raising the federal funds rate 11 times between March 2022 and July 2023.
Wednesday’s 25 basis point cut in the short-term federal funds rate was the third approved since September 18, lowering the benchmark rate by a full percentage point from a range of between 5.25 percent and 5.5 percent – the highest level since then. 2001.
“As the economy improves, monetary policy will adjust to better promote our employment and price stability goals,” Powell said. “If the economy remains strong and inflation does not continue to rise above 2 percent, we can dial back the policy gradually. If the labor market were to weaken unexpectedly or inflation were to fall faster than expected, we could ease policy very quickly. The policy is well positioned to deal with the risks and uncertainties we face in pursuing both sides of our dual mission. “
‘Limited reinforcement’ is a continuation
To keep interest rates low during the Great Depression, the Fed has been buying $80 billion in long-term Treasury notes and $40 billion in mortgage-backed securities (MBS) every month, expanding its balance sheet to $8.5 trillion is unprecedented.
As worries about inflation began to grow in 2022, the Fed reversed course and used “quantitative tightening.”
In the implementation letter, the Fed said it would continue to tighten rates at the current reduced pace, which allows $25 billion in maturing Treasuries and $35 billion in mortgage-backed securities (MBS) to exit its books each month.
But because mortgage rates are still so high that few homeowners have an incentive to refinance, the Fed’s passive approach to monetary tightening has only allowed it to shrink its MBS balance sheet by about $15 billion a month.
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