The Fed Cuts, but Weekly Mortgage Rates Rise

Banks don't always act the way you expect them to, and this week is an example. The Federal Reserve cut short-term interest rates on Dec. 18. So what did mortgage rates do? They went up.

The average 30-year fixed mortgage rate climbed 0.12 percentage point in the week ending Dec. 18, to 6.66%. Yet the Fed moved in the other direction, reducing the federal funds rate by 0.25 of a percentage point.

Mortgage rates and the federal funds rate often move in the same direction. But sometimes they diverge, as they did this week. Usually this happens because the two rates operate on different time frames. When a lender gives you a 30-year mortgage, it considers the economy's long-term outlook. The federal funds rate, in contrast, is the rate that banks pay each other for overnight loans — a very short-term outlook.

Investors and the Fed see things differently

The mortgage market is signaling that elevated inflation will stick around because the economy will keep roaring along. The Fed, on the other hand, seems to think that the inflation rate remains on track to fall to the central bank's goal of 2%. "Inflation has made progress toward the Committee's 2% objective but remains somewhat elevated," the Federal Reserve's rate-setting committee said in its Dec. 18 statement.

In short, there's uncertainty over the direction of the economy, especially with a new presidential administration due to be sworn in in January. "Right now, it really feels like what's really dominating rate movements is fiscal policy," says Chen Zhao, head of economic research for Redfin, the real estate brokerage. Tax cuts and new tariffs, if instituted, could push prices higher. And when inflation goes up, mortgage rates tend to follow.

Financial markets page Dr. Feelgood

It looks like the financial markets, including the one for mortgages, believe that fiscal stimulus is on the way in the form of tax cuts, which could turn out to be inflationary. Investors seem to be overlooking the prospects of higher tariffs or mass deportations, which could deliver a combination of higher prices and stagnating economic growth.

In the 1970s they called this sinister combo "stagflation." It ended with twin recessions from 1979 to 1982. Investors don't appear to be worried that this ancient history will repeat.

"Sentiment is euphoric," wrote James Mackintosh, senior markets columnist for the Wall Street Journal, in a Dec. 17 column. He didn't mean that in an exuberant way. Like a math teacher chaperoning a prom, he eyed the punch bowl suspiciously. Mackintosh's column warned that "trouble might be imminent for stocks."

But how realistic is the Fed?

While investors get high on their own supply and push interest rates upward on the belief that the next administration will deliver what they want, the Fed won't react to fiscal policies until they are enacted. The central bank portrays itself as soberly focusing on facts, not on conjecture.

But the fact is that the inflation rate crept higher in October and November. This contradicts the Fed's stubborn assertion that inflation is headed toward its 2% goal.