How the Federal Reserve Affects Mortgage Rates

The Federal Reserve influences mortgage rates, but doesn't set them. On Nov. 7, 2024, the central bank reduced the federal funds rate by one-quarter of a percentage point to a range of 4.5% to 4.75%, a smaller cut than the one announced at the September meeting but a cut nonetheless. In the news release accompanying the announcement, the committee members noted that there's still progress to be made on employment and inflation.

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 a year before beginning to cut rates in September 2024. Its next meeting is Dec. 17-18, 2024. Financial markets expect another reduction at that meeting.

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 above that for some time, which is why the Fed held interest rates on the high side. The idea is that higher borrowing costs will slow the economy and bring down inflation.

The consumer price index increased 0.2% in September, the Bureau of Labor Statistics announced Oct. 10, to an annual rate of 2.4%. The core CPI, which excludes food and energy prices, was up 3.3% year-over-year.

That September number is still above the Fed's target rate, but it's darn close. Inflation hit the highest rate in 40 years back in June 2022, capping off a pandemic-era rise at 9.1%. As inflation slowed, the Fed was able to shift from hiking interest rates to holding rates steady to, most recently, cutting. If the rate of inflation were to fall below 2%, the central bankers would likely pivot again.

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.

The most recent jobs report did not send an especially clear message to the Fed. In October, the U.S. added just 12,000 jobs, well below economists' expectations. But because events including major hurricanes and labor strikes likely contributed to the low tally, the data is not necessarily a sign that the economy is in trouble. Unemployment held steady, which also bolsters a rosier view.

» 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.

Lately, mortgage rates have been dancing to their own drummer. So far this year, mortgage rates mostly rose from January through May, then fell from May through September — almost entirely while the Fed held interest rates steady. The Fed announced its rate cut Sept. 18, yet mortgage rates began a fairly steep rise shortly after.

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.