How the Federal Reserve Affects Mortgage Rates

The Federal Reserve influences mortgage rates, but doesn't set them. At its Sept. 18, 2024, meeting, the central bank reduced the federal funds rate by half a percentage point to a range of 4.75% to 5%, a significant cut after holding rates steady for the past 14 months. In a news release, the committee noted that job growth has slowed since August, and inflation has made further progress but remains higher than its objective of 2%.

Mortgage rates are influenced by many elements, including the inflation rate, the pace of job creation, and whether the economy is growing or shrinking. The Federal Reserve's monetary policy is a factor, too, and is set by the Federal Open Market Committee.

What the Federal Reserve does

The Federal Reserve is the nation's central bank. It guides the economy with the twin goals of encouraging job growth while keeping inflation under control.

The FOMC pursues those goals through monetary policy: managing the supply of money and the cost of credit. Its main monetary policy tool is the federal funds rate, which is the interest rate that banks charge one another for short-term loans. Although there's no such thing as "federal mortgage rates," the federal funds rate influences interest rates for longer-term loans, including mortgages.

The FOMC meets eight times a year, roughly every six weeks, to tweak monetary policy. The Federal Reserve maintained the federal funds rate in a range of 5.25% to 5.5% for more than two years before the Sept. 18, 2024, rate cut. Its next meeting is Nov. 6-7, 2024. Financial markets expect another reduction at that meeting. In its economic projections, the Fed left the door open to more rate cuts, signaling another half percentage point by the end of the year. Time will tell if that happens in small increments or all at once.

The Federal Reserve, mortgage rates and inflation

Mortgage rates respond to many economic signals besides the federal funds rate. One major influence is inflation. The Fed's goal is to maintain an inflation rate of around 2%. Inflation has been well above that for some time.

The consumer price index increased 0.2%in August, the Bureau of Labor Statistics announced Sept. 11, to an annual rate of 2.5%. The core CPI, which excludes food and energy prices, was up 3.3% year-over-year. Despite the improvement, these numbers are still slightly higher than the Fed wants.

These numbers are higher than the Fed wants, but demonstrate recent improvement. Progress on inflation stalled in the first quarter of 2024. As a result, investors pushed back their expectations for the timing of rate cuts. At the beginning of the year, they thought the first rate reduction would happen in spring. Now they think it's mostly likely to happen in the fall.

The availability of jobs also influences monetary policy. When the economy is creating lots of jobs, it means the economy is growing — a situation that tends to push the inflation rate higher. The Fed responds by raising interest rates. When job creation slows down, or when many people lose their jobs, inflation tends to fall. The Fed responds by cutting interest rates. With an aggressive rate cut at its September meeting, the Fed is signaling its confidence in achieving a “soft landing.” Since inflation has gone down, the Fed can afford to take a bigger swing in response to a cooler-than-expected labor market.

» MORE: How mortgage rates are determined

Do mortgage rates follow Fed rates?

The Fed and the mortgage market move like dance partners: Sometimes the Fed leads, sometimes the mortgage market leads, and sometimes they dance on their own.

The federal funds rate and mortgage rates usually move in the same direction. But it's sometimes hard to say whether mortgage rates follow the Fed's actions or the other way around.

The FOMC prefers to give investors a heads-up whenever it plans to raise or cut short-term interest rates. Members of the committee advertise their intentions by sprinkling hints into their public speeches. By the time the committee meets, there's usually a consensus among investors as to whether the Fed will cut rates, raise them or keep them unchanged.

As that consensus solidifies before an FOMC meeting, mortgage rates usually drift in the direction that the Fed is expected to move. Often, by the time of the meeting, mortgage rates already reflect the expected rate change.

At the same time, mortgage rates move up and down daily in reaction to the ebb and flow of the U.S. and global economies, which are the same developments that the Fed responds to.

» MORE: Compare current mortgage interest rates

Federal funds rate and HELOCs

Although there's merely an indirect link between mortgage rates and the federal funds rate, the Fed does have a direct influence on the rates charged on home equity lines of credit, which typically have adjustable rates.

Interest rates on HELOCs are linked to the Wall Street Journal prime rate, which is the base rate on corporate loans by the largest banks. The prime rate, in turn, moves with the federal funds rate. The prime rate is 8%.