Fed Raises Rate, but Why?

Fed Rate Hike Context & Impact

This has been a very volatile week for mortgage rates. Let’s talk about the big news item first: the Federal Reserve (Fed) raised its Fed Funds Rate target by 0.25%, increasing the range to 3.75%–4.00%. This was virtually 100% expected before the meeting.

We need to understand that the increase in this rate did NOT directly affect mortgage rates. The Fed Funds Rate is the rate banks charge each other for short-term/overnight borrowing. Think of it as the shortest-term loan available and mortgages as the longest-term loan. Credit cards, auto loans, and home equity lines of credit are affected by this rate change.

A rise in short-term rates will eventually “trickle down” to long-term rates, but it is gradual. What affects long-term rates more is the expectation of future monetary policy, inflation, and the economy.

The Fed’s Focus on Inflation vs. Growth

When the Fed raises rates, they are trying to put the brakes on the economy. Borrowing costs go up, so businesses and consumers spend less. This slows the economy and slows inflation. That is the central goal of the Fed. They believe employment is stable (even though we have greatly discussed that this is far from stable), so they are focusing on inflation.

The Fed’s established policy of 2% core inflation, as shown on the Personal Consumption Expenditures report, has been around since 2012. Since that time, core PCE has rarely been at or below 2%. During COVID, there was less spending, and we saw sub-2%. During 2012–2017, core PCE was below 2%, but the Fed was struggling to increase inflation during that period. It was too low. Given that core PCE has been trending lower, this was an odd economic move for the Fed to hike rates.

Fed Says Inflation Progress Too Slow

Chairman Warsh stated, “We must be confident that underlying inflation is moving to our objective clearly and at sufficient speed. Today, the FOMC decided that this standard has not been satisfied.”

Possible Motives Behind Rate Hike

So why did they raise rates? Maybe they believed that inflation isn’t really coming down. This is hard to believe, as they should be well aware of the lag in shelter, the artificial high in financial advisory fees due to the stock market skyrocketing, and inflationary effects of the Iran conflict that are beyond their control.

This could also have been a political rate hike. Markets believe the independence of the Fed has been under attack. This rate hike, with a unanimous 12–0 vote, calms this concern for markets. Chairman Warsh also left the door open to future hikes in pursuit of the elusive 2%. This was supported by the dot plot (summary of economic projections) showing 16 out of 18 members projecting at least one more rate hike this year.

Market Reaction: Yields And BOJ Move

After the Fed press conference, mortgage rates hit fresh highs, and the 10-year Treasury hit the psychologically impactful 5.00% yield. In addition to the previously mentioned Fed thoughts, the Bank of Japan raised its benchmark rate by 0.25%. This should have been positive news for our bond yields. Unfortunately, they have two dissenters on their board, which markets interpreted as not having the resolve to get the job done.

Energy Pressures from Saudi Pipeline

Saudi Arabia’s East–West pipeline is still causing energy price pressures. They are stating it will likely be another 3–5 weeks before repairs are completed and volume restored. However, there are no guarantees the Houthis won’t carry out another strike.

Looking Ahead: Calmer News Week

• Tuesday, September 22: ADP Weekly Employment
• Wednesday, September 23: Mortgage Applications
• Thursday, September 24: Jobless Claims, New Home Sales
• Friday, September 25: Durable Goods Orders