A variety of factors influence mortgage rates, including economic indicators and global events. The Fed’s actions to rein in inflation, for example, indirectly impact 30-year fixed mortgage rates.
If you go to the grocery store and chicken thighs cost more or fuel prices rise, you know the economy is experiencing inflation. But what exactly does inflation mean for home buyers?
Inflation
While it may sound like a bad thing, inflation can actually be beneficial to home buyers. Inflation refers to the rate at which prices for goods and services increase over a period of time, most often in a year. It can be broadly calculated across a country or more narrowly for particular types of goods or services, such as food. Inflation is important to mortgage rates this week because it affects the purchasing power of money. When inflation is high, the purchasing power of money decreases and lenders must compensate by charging higher interest rates.
Inflation can be caused by a number of factors, including an overheated economy, higher demand for goods and services or more money in circulation. Inflation can also be a result of government policies that seek to stimulate the economy and drive consumer spending. The COVID-19 pandemic was one example of this, with the federal government giving people money to spend and allowing businesses to close during the pandemic. This fueled consumer demand for entertainment centers, new TVs, computers, outdoor toys and exercise equipment, among other items. This, in turn, fueled supply issues and increased costs for those items. This type of inflation is called demand-pull inflation.
When inflation is not controlled, it can lead to economic instability. It is important for central bankers to keep an eye on inflation and act quickly to slow the economy down when necessary. It is also important for policymakers to set targets for inflation that are realistic, such as 2%, so consumers and businesses can adjust accordingly.
Inflation can be especially good for home buyers with fixed-rate mortgages because it reduces the present value of their future mortgage payments and leads to rising home prices. However, when the rate of inflation spikes and mortgage rates rise with it, homebuyers may experience difficulty finding affordable homes. This is because when interest rates rise, the number of buyers seeking mortgages drops, and prices and home values begin to fall as a result. Inflation is not the only factor that can impact mortgage rates, but it is a key driver that should be monitored closely by investors and borrowers.
The Fed
When inflation runs too hot, the Federal Reserve (the central bank of the United States) will typically respond by raising interest rates. That makes it more expensive for banks to borrow, which in turn raises mortgage rates. Inflation is a threat to the purchasing power of money, and when it’s too high, it causes wages and prices to rise over time. That’s why the Fed is always monitoring inflation.
To combat inflation, the Fed tries to keep its target inflation rate of 2%. The goal is to prevent consumers from spending more than they can afford, which leads to overspending and ultimately a recession. If the economy does start to slow, the Fed will then lower interest rates to encourage consumers and businesses to spend less.
The Fed sets a target range for the interest rate it charges banks to borrow overnight from each other, called the Federal Funds Rate. It uses open market transactions to nudge the rate into its target range. This directly affects short-term rates like mortgage rates, but it also impacts long-term rates like the 10-year Treasury bond yield.
In the past 14 months, the Fed has raised its interest rate 10 times, which has led to higher mortgage rates for borrowers. Inflation and mortgage rates tend to move in tandem, so when mortgage rates are rising, it’s often because of a combination of factors like inflation and a strengthening economy.
A higher rate of inflation reduces the purchasing power of a dollar, which in turn reduces homebuyers’ ability to afford their mortgage payments. The lower purchasing power of the dollar makes mortgage loans more expensive for lenders, which then translates into higher mortgage rates for homebuyers.
However, not all inflation is created equal. For example, a rise in the cost of eggs is likely temporary and unlikely to affect the overall economy, but a rise in the price of medical care might be more concerning. The Fed monitors inflation to determine whether or not it will become a persistent problem, which can cause lasting harm to the economy and the people in it.
Global Events
A number of events that occurred this week shook the markets and sent mortgage rates up and down. The Fed’s hawkish comments and a potential economic slowdown in the Eurozone sent the 10-year Treasury yield up, driving mortgage rates higher, but a weaker-than-expected core inflation reading caused them to fall back again.
The first factor was the failure and subsequent bailout of Silicon Valley Bank, which sparked fears of additional banking problems. This pushed investors to seek safety in the US Treasury market, driving demand for bonds and pushing their yields lower, thus causing mortgage rates to decline.
The second event was the sudden collapse of the Turkish lira, which sent markets into turmoil and sparked fears of a wider global economic slowdown. This also pushed investors to seek safety in the US bond market, driving demand for mortgage bonds and pushing their yields lower, again causing mortgage rates to decline.
Traditionally, inflation and mortgage rates go hand-in-hand: When inflation rises, mortgage rates tend to increase so lenders can earn the interest they need to cover their costs. But high inflation also sends prices of everything, including homes, up, which makes it harder for homebuyers to afford the loans they need.
To combat this, the Federal Reserve raises mortgage rates to make it more expensive for people to borrow money. But this doesn’t always help. Typically, when the Fed raises mortgage rates, it also increases interest rates on other types of loans, such as car and credit card payments. As these other rates also rise, they can offset the impact of inflation on home buying, making it less costly for homeowners to own their homes.
Despite these factors, experts still expect mortgage rates to decline over the next few weeks. They’re predicting that, as the Fed’s rate-raising cycle winds down and inflation cools off, the average 30-year fixed mortgage rate should dip below 5%. That would be a big step in the right direction for the many prospective homeowners looking to get into the housing market this year. But for many, it will still be a challenge to find a good, affordable loan.
Mortgage Rates
A rising mortgage rate typically makes it more expensive to buy a home, and a higher interest rate also decreases the value of savings. In turn, this can reduce the number of people who are interested in buying a new home. This may cause housing prices to decline and the supply of homes on the market to fall.
In addition to global events, mortgage rates often rise and fall based on economic indicators. For example, the Federal Reserve’s monetary policy decisions can have a big impact on mortgage rates. The Fed is the central bank of the United States and works to encourage growth and keep inflation low.
As a result, mortgage rates tend to move in line with the Fed’s actions. If the economy is doing well, mortgage rates usually rise to make it more affordable for borrowers to take out loans. Conversely, if the economy is struggling, mortgage rates typically fall to encourage borrowing and spending.
Besides inflation, other factors that influence mortgage rates include the stock market and the Federal Reserve’s monetary policy decisions. The stock market can plummet if investors are concerned about the future of the economy. If this causes the demand for mortgage bonds to decrease, mortgage rates may also fall.
The Fed also influences mortgage rates by setting the amount of money it will lend to banks. During the COVID-19 pandemic, the Fed bought agency mortgage-backed securities (MBS) to increase demand and keep rates low. However, the Fed has begun scaling back these purchases in recent months.
While mortgage rates don’t respond to the same factors as the stock market, they still do respond to inflation and the Federal Reserve’s monetary policies. If the economy is improving and inflation is cooling, mortgage rates are likely to follow suit. Fortunately, homeowners with fixed-rate mortgages can rest easy in the face of inflation because their contract stipulates a certain rate for the life of their loan. However, homeowners with adjustable-rate mortgages, or ARMs, will be affected by a rise in mortgage rates. If the rate hike is steep enough, ARMs can become unaffordable for borrowers.
Conclusion
Inflation can have a significant impact on mortgage rates this week and in general. Inflation occurs when there is an increase in the overall price of goods and services, leading to a decrease in the purchasing power of money.
When inflation rises, the Federal Reserve may increase interest rates to combat the rise in prices. This increase in interest rates can cause mortgage rates to rise as well, as lenders will need to charge higher rates to compensate for the increased cost of borrowing money.
On the other hand, if inflation is low, the Federal Reserve may choose to keep interest rates low, which can lead to lower mortgage rates.
Here are some FAQs related to inflation and mortgage rates:
- How does inflation affect mortgage rates?
Inflation can cause mortgage rates to rise if the Federal Reserve increases interest rates to combat rising prices. When interest rates rise, lenders need to charge more to make up for the increased cost of borrowing money, resulting in higher mortgage rates.
- What is the relationship between inflation and interest rates?
There is a direct relationship between inflation and interest rates. When inflation rises, the Federal Reserve may increase interest rates to combat rising prices. When interest rates rise, borrowing money becomes more expensive, which can help to slow down inflation.
- How can I protect myself from inflation’s impact on mortgage rates?
To protect yourself from inflation’s impact on mortgage rates, you can consider locking in a fixed-rate mortgage with a low interest rate. A fixed-rate mortgage will provide you with a set interest rate for the life of the loan, which can help to protect you from rising interest rates due to inflation.
In summary, inflation can have a significant impact on mortgage rates this week and in general. If inflation rises, the Federal Reserve may increase interest rates, causing mortgage rates to rise as well. To protect yourself from inflation’s impact on mortgage rates, consider locking in a fixed-rate mortgage with a low interest rate.
