Investors who fund most mortgages have already factored in several rate cuts, so further decreases could be influenced by what the upcoming “dot plot” reveals about expectations for future rate cuts.
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The Federal Reserve is widely anticipated to initiate rate cuts next week, and solid data supporting the argument of a slowing economy could encourage policymakers to make an assertive move.
This week, stocks saw widespread gains as investors adjusted to the possibility of a 50 basis-point cut in short-term rates by the Fed on Sept. 18, rather than a more cautious 25-basis point reduction. A basis point is equivalent to one-hundredth of a percentage point.
However, investors who provide funding for the majority of mortgages have already factored in multiple Fed rate cuts for this year and the next. The continuation of mortgage rate declines may rely on the disclosure of the “dot plot” next week, which will showcase policymakers’ expectations for the pace of future rate cuts.
The CME FedWatch tool, which monitors futures markets to gauge investor sentiment regarding future Fed actions, now places a 45 percent probability of a 50 basis-point cut on Sept. 18, up from 15 percent on Wednesday.
The shifts in futures market predictions followed the release of Thursday’s Producer Price Index (PPI) and weekly initial unemployment claims.
Both of these data releases from Thursday supported the notion that the consistent decline in inflation witnessed in recent months is not temporary, despite a notable uptick in prices in August as reported in the latest Consumer Price Index (CPI) data.
The CPI report from Wednesday revealed that core inflation, excluding volatile energy and food prices, rose by 3.26 percent from the previous year in August, driven by increased costs for shelter, airline fares, auto insurance, education, and apparel.
While the Fed’s preferred inflation measure is the personal consumption expenditures (PCE) price index, which showed a 2.5 percent annual growth in July, half a percentage point above the Fed’s 2 percent target.
Thursday’s PPI report is significant for markets as it will be used to calculate the August PCE price index, scheduled for release on Sept. 27.
Economists at Pantheon Macroeconomics maintained their expectation of a 25 basis point rate cut by the Fed next week.
However, the latest PPI and CPI data suggest that inflation may reach the Fed’s 2 percent target by the second quarter of 2025, allowing the Fed to pursue more aggressive easing as unemployment levels rise, according to Pantheon economists in their latest U.S. Economic Monitor released on Friday.
Jobless claims slightly rise
The jobs report from Thursday indicated a slight increase in initial jobless claims last week, reaching 230,000, still below the July average of 240,000.
Pantheon economists believe that the higher level of claims in July was mainly due to the disruption caused by Hurricane Beryl and a higher concentration of auto plant shutdowns for retooling.
In addition, only 142,000 jobs were created last month, and Pantheon economists predict that employment growth will continue to slow if, as expected, tight credit conditions and a slowdown in household expenditure growth have a greater impact on hiring.
Mortgage rates decline throughout the summer
Data from rate-lock tracking by Optimal Blue indicates that since reaching a high of 7.27 percent in April 2024, rates on 30-year fixed-rate conforming mortgages have decreased by over a percentage point. Rates for 30-year conforming loans hit a new low of 6.10 percent on Wednesday in 2024, with borrowers securing FHA loans at an average rate of 5.92 percent.
Whether mortgage rates will continue to decrease may hinge on the “dot plot” and the Fed’s upcoming Summary of Economic Projections, revealing each Federal Open Market Committee member’s opinion on future rate cuts.
Futures market investors are betting on a reduction of at least 2.25 percentage points in short-term rates by mid-2025. Investors who provide funding for most mortgages have already factored these expectations into the yields they demand for mortgage-backed securities (MBS).
While Pantheon forecasters expect a modest rate cut next week, they anticipate the Fed to aggressively lower short-term rates in the coming months by a total of 2.75 percentage points by the middle of next year.
As a significant portion of expected rate cuts has been incorporated into long-term rates, Pantheon predicts that yields on 10-year Treasury notes — a reliable indicator of future mortgage rates — will only decrease by 58 basis points over the same period.
Mortgage rates may have room to fall further, as the “spread” between 10-year Treasury yields and 30-year fixed-rate mortgages narrows, indicating decreased concern among MBS investors regarding prepayment risk.
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