According to Federal Reserve Chairman Jerome Powell in March 2021, these price increases will only have transient effects on inflation. Thereafter, “transitory inflation” became the phrase of the year in economics, with high hopes that inflation would return to its regular programming and maybe even deflate after the initial supply chain shocks and government stimulus wore off.
Despite trillions of dollars of stimulus and near-zero interest rates, inflation did not become “transitory.” Instead, it was the beginning of a new era.
How Do You Interpret “Transitory Mortgage Rates”?
A transitory inflation rate is defined as an inflation rate that is higher for a short period before falling back to its normal level. The Fed has raised interest rates in a manner that is the opposite of persistent inflation, which has affected us over the last two years.
Federal funds rates have a great impact on mortgage rates, but their movements are subject to their own fluctuations. Mortgage rates are usually influenced by bond yields after all. Considering this, how can they currently be in a transient state?
Since October, the average 30-year mortgage rate has decreased by over 1% despite the federal funds rate remaining at 5.25-5.5%. In other words, mortgage rates are returning to their base naturally after a period when they were higher. Even without the Fed cutting rates, mortgage rates might be able to continue decreasing despite the wider spread between bond yields and mortgage rates.
But by how much? Rates on 30-year mortgages tend to be within 1-2% higher than those on 10-year Treasury bills. In today’s market, the spread is around 2.7%. Looking at it from the most basic perspective, it means that mortgage rates can fall anywhere from 0.7% to 1.7% without lowering the federal funds rate. As a result, the 30-year mortgage rate average could drop to as low as 5% if that were the case.
A 30-year mortgage rate of 3-5% was typical during the decade preceding 2020 and the pandemic. A rate that was higher than its base rate for a short period before returning to its base rate, if mortgage rates were to keep falling until they reverted to their typical spread, would effectively be a “transitory mortgage rate.”
If the Fed lowers rates, does this change?
With prolonged easy money policies, economies risk overheating due to low interest rates. For the better part of two years, inflation was at an absurdly high level. In the past few years, we have seen record-breaking home prices, increases in gas prices, increases in grocery store prices, and so on. No matter whether mortgage rates drop organically or not, the Fed’s decision-making remains the same. They are looking at the inflation rate and the unemployment rate.
Inflation had to be beaten with federal funds rate hikes, even though the Fed was late to the party. In November, personal consumption expenditures (PCE) fell to 2.6%, which is great progress, but will a premature rate cut cause that number to spike again?
A decision must be made by the Fed in 2024. Either they let rates remain steady or they risk a slowdown that will be much more painful than expected. Alternatively, lower rates and risk overheating inflation once again. It is easier to stomach the first option, but it is still a concern. It is the sole purpose of the Fed to control inflation and unemployment, not home costs, so the Fed would be delighted to see mortgage rates fall on their own.
Having low inflation and low mortgage rates is good for us. We shouldn’t complain if the Fed continues to hold off on lowering rates and keeps inflation under control while mortgage rates continue to decline. We’ll just have to wait and see what happens.
