What if Jerome Powell Doesn't Lower the Federal Funds Rate in September?
Last week I wrote the following poem and a fun way to describe how the market is feeling about the upcoming September Federal Reserve meeting:
T’was 2 weeks before the Federal Reserve Meeting, and at every open house,
Not a buyer was talking about locking, not even to their spouse.
The stock market clung onto what the Federal Reserve has said with care,
In hopes that a half point rate drop would soon be there.
Homebuyers were all nestled in their new home’s brand-new bed,
While visions of a refinance danced in their head.
The bank industry waiving its white ‘kerchief, I with my lender’s cap,
Had just settled our brains in for a long winter’s nap.
When out of Jackson Hole, Wyoming there arose such a clatter,
Loan Officers sprang from their home office to see what was Jerome Powell’s chatter.
He said, “The time has come for policy to adjust”.
We all agree and think that the rate drop is a must.
On September 18th, we all hope to hear him exclaim, ere he drove out of sight—
“Happy Refi Business to all, and to all a good night!”
I posted this poem in some Mortgage Social Media groups, just to get a ‘temperature’ reading if other Loan Officers out there are ‘feeling’ the same sort of vibes as I was after last week’s Federal Reserve Meeting in Jackson Hole, Wyoming. Here is a link to Jerome Powell’s speech in case you are looking for some late-night reading. https://www.federalreserve.gov/newsevents/speech/powell20240823a.htm
In case you haven’t heard already, in this meeting Jerome Powell telegraphed the Federal Reserve’s actions for it’s upcoming September 17-18th meeting by stating that the time has come for “policy to adjust”. What the stock and bonds markets have interpreted this as – is that there is a 100% chance that Federal Funds Rate will be lowered by 0.50%.
As a reminder, the Federal Funds Rate is the interest rate at which banks lend reserve balances to one another overnight. (Although a scary thought is that as of 2020, the Federal Reserve does not require a bank to hold ANY reserves to meet obligations or withdrawals by or to its customers). However, that said lowering the Federal Funds rate does and will have an impact on the banking system.
If the Federal Funds rate is dropped, it allows the banking system to lower its “Prime Rate”. The prime rate is the interest rate that banks and credit unions charge their most creditworthy customers for loans and credit accounts. It's usually the lowest rate of interest that banks will charge. Virtually EVERY SINGLE VARIABLE RATE loan (from Credit Cards to reverse mortgages to Adjustable Rate Mortgages to your Home Equity Line of Credit) is tied to the Prime Rate. If you look at your credit card statement, you will see how your rate is calculated. It will likely state that it is the Prime Rate + x amount in margin. So if the prime rate is raised or lowered, your rate on that respective loan is raised or lowered (inside the ceiling and floor rates)
Fixed Rate Mortgages are NOT tied to the Prime rate. I’ve received emails and calls from former (and hopefully future clients as well) that they are wanting to lock in their rate (or start a refinance) literally on September 19th, as their preconceived notion is that mortgage rates will naturally fall by 0.50% as well on the 18th if the Federal Reserve drops the Federal Funds rate by 0.50% - thinking there is a 100% correlation there. Again, fixed mortgage rates are not directly correlated to the Federal Funds rate.
So what are they tied to? Just like the stock market, they are tied to current market conditions and future probabilities. Think of it this way. Today’s mortgage rates are based on tomorrow’s expectations. If the expectation is that there is a 100% chance that Jerome Powell’s crew is going to lower the Federal Funds rate – that is already built into today’s mortgage rates.
So, on September 18th, if he announces the 0.50% drop in the Federal Funds rate – there is likely not to be any movement in mortgage rates. If there is movement, it will only come from any telegraphing he does for the Federal Reserve meeting upcoming in December (which there is already an expectation that he’ll announce that he is going to continue dropping the Federal Funds rate in December as well).
The concerning thing to me is that what if the Federal Reserve does NOT lower the Federal Funds rate on September 18th? When he mentioned that “policy must adjust”, everyone’s eyes went straight to the Federal Funds rate. The Federal Reserve has many levers inside of economic policy. They can start to cool their influence on inflation, GDP, and unemployment and still not touch the Federal Funds rate yet.
The Federal Reserve actually has 3 main levers it can pull (there many other smaller ones). The Federal Funds rate is only one of the three. Here are the other 2:
1) Buying or selling of government bonds (mostly treasury and mortgage-backed security bonds) to impact the money supply. https://fred.stlouisfed.org/series/TREAST
2) Reserve Requirements. If they changed the Reserve Requirements from zero to anything but zero – they can pull money out of the economy incredibly quickly.
What if the decision to “adjust policy” comes from one of these other 2 levers? Or what if the Federal Funds rate is only lowered by 0.25%, or what if it’s lowered by 0.75%?
In my opinion, the market is too laser focused on this potential 0.50% rate drop, any news other than this on September 18th will be like the example I’ve used over the years in that it will be like me doing a cannon ball into our kid’s small backyard above ground swimming pool. The mortgage and stock markets have taken their eyes off anything of periphery focus outside of the rate drop.
To come back to the last two lines in the poem, I hope what Powell subjectively suggested (a change in policy) does in fact mean a 0.50% Federal Funds rate drop. Not doing so will have a substantial impact on the markets and add some debris onto the tarmac of Jerome Powell’s attempted ‘soft landing’.
* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.