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Mortgage rates and 10-year Treasury yields rose sharply on Monday to levels not seen since July, as bond market investors continue to weigh whether Fed policymakers have licked inflation.
Long-term interest rates have been on the rise for a month, after the Federal Reserve on Sept. 18 served up a dramatic 50 basis-point rate cut accompanied by a cautious forecast that suggested policymakers would bring rates down more gradually in the future.
Public remarks Monday from two Fed policymakers who are seen as inflation hawks shed some light on that approach, leading some investors to bet that the Fed will only cut rates once more this year.
In addressing the Securities Industry and Financial Markets Association’s annual meeting Monday, Dallas Federal Reserve President Lorie Logan issued her second warning in a month that she doesn’t think inflation risks have vanished.
Lorie Logan
“Two takeaways stand out to me from the current economic and financial picture,” Logan said. “First, the economy is strong and stable. But second, meaningful uncertainties remain in the outlook. Downside risks to the labor market have increased, balanced against diminished but still real upside risks to inflation. And many of these risks are complex to assess and measure.”
Logan expressed similar views at an Oct. 9 energy conference, saying that while “upside risks to inflation have diminished, they have not vanished. I continue to see a meaningful risk that inflation could get stuck above our 2 percent goal.”
Minneapolis Federal Reserve Bank President Neel Kashkari expressed similar views Monday at a town hall event hosted by Wisconsin’s Chippewa Falls Area Chamber of Commerce, saying he expects any rate cuts in the months ahead to be modest.
“If the labor market weakens surprisingly, that would cause me to take a fresh look at my dots,” Kashkari said of the “dot plot” that tracks Fed policymakers’ expectations of where they think short-term rates should be in the months ahead.
Futures markets tracked by the CME FedWatch tool show investors on Monday see a 31 percent chance that the Fed will only approve one more 25 basis-point rate cut this year, up from 22 percent Friday. On Sept. 20, futures markets were pricing in a 74 percent chance of at least 75 basis points of further cuts this year.
10-year Treasury yield climbing
Source: Yahoo Finance.
Yields on 10-year Treasury notes, a barometer for mortgage rates, climbed 11 basis points Monday, to 4.18 percent. That’s more than half a percentage point higher than the 2024 low of 3.60 percent registered on Sept. 17.
Rates on 30-year fixed-rate conforming mortgages have posted similar gains since hitting a 2024 low of 6.03 percent on Sept. 17, according to rate lock data tracked by Optimal Blue.
Mortgage rates on the rebound
Optimal Blue data showed borrowers were locking rates on 30-year conforming loans at an average of 6.45 percent Friday, with rates on jumbo mortgages at 6.88 percent.
Although rate lock data tracked by Optimal Blue lags by a day, a Mortgage News Daily index showed rates on 30-year fixed-rate loans were up 14 basis points on Monday, to 6.82 percent.
Rising costs for shelter, auto insurance, medical care, apparel and airline fares drove the Consumer Price Index up 0.2 percent from August to September — about twice what economists had forecast.
The Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, had previously shown inflation cooling to 2.24 percent in August — not far from the Fed’s 2 percent goal. The PCE index for September will be published Oct. 31.
Another worry for bond market investors who fund most mortgage lending is “quantitative tightening” — the Fed’s ongoing program to trim its massive holdings of government debt and mortgages.
To head off a recession during the pandemic, the Fed was buying $120 billion in debt every month — $80 billion in long-term Treasury notes and $40 billion in mortgage-backed securities (MBS) — helping bring long-term rates to historic lows.
Fed ‘quantitative tightening’
Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis.
The Fed’s cumulative Treasury and MBS holdings peaked at $8.5 trillion in May 2022. Since then the central bank has allowed $1.86 trillion in assets to roll off its books.
At $2.28 trillion as of Oct. 16, the Fed’s MBS holdings are down 17 percent from $2.74 trillion April 2022.
The Fed’s quantitative tightening strategy is aimed at letting up to $25 billion in maturing Treasurys and $35 billion in mortgage-backed securities (MBS) roll off its books each month.
But because the central bank has been unable to hit its target of allowing $35 billion in maturing mortgage-backed securities (MBS) to fall off its balance sheet each month, it may eventually have to resort to selling those assets, Logan noted.
In the long run, the Fed wants to offload most of its mortgage debt and hold mostly Treasurys, but “we are rather far from that benchmark and not moving appreciably closer,” Logan said.
Because homeowners have little incentive to refinance mortgages taken out when rates were lower, the Fed has only been able to trim its MBS holdings by about $15 billion a month.
Some members of the Federal Open Market Committee have suggested “it could be appropriate at some point to sell MBS to move the mix of assets closer to our goal,” Logan said. “But that’s not a near-term issue in my view.”
Last fall, as mortgage rates were climbing to post-pandemic highs, the National Association of Realtors and trade groups representing lenders urged the Fed to stop trimming its mortgage holdings.
The groups, including Community Home Lenders of America and the Independent Community Bankers of America, cited the abnormally wide “spread” between 10-year Treasury yields and mortgage rates as a factor adding to affordability challenges for homebuyers.
Noting that it’s sometimes suggested that the Fed’s quantitative tightening “works at cross purposes” to rate cuts, Logan said she disagrees.
“Normalizing our balance sheet means bringing our asset holdings down from the elevated quantity that was necessary to support the economy during the pandemic and returning to a balance sheet size that will be consistent with implementing monetary policy efficiently and effectively,” Logan said.
“Those two normalization processes work in tandem and are consistent in my view. A number of other central banks are similarly reducing their asset holdings while lowering their policy rates in response to the changing economic outlook.”
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