After holding short-term interest rates at multi-decade highs for over a year, the Fed has finally begun easing, starting with a 50-basis point cut to the fed funds rate in mid-September.
That cut was subsequently followed by a 25-basis point cut in November and, according to the CME FedWatch tool, the market expects that rate cutting to continue with another 25-basis point cut at the December meeting.
But, despite those cuts, 10-year Treasury yields have risen steadily since then, going from 3.80% to 4.40% (and even touching 4.50%), their highest level since the summer months.
At the same time, the average 30-year mortgage rate has risen from 6.1% to 6.8%, seemingly the exact opposite of what the Fed intended.
What gives?
Well, for one thing, economic data (and the expectations for a strong economy) has been improving.
It started on October 4, when the September jobs report came in much better than the previous two months: 254,000 jobs added and the drop to a 4.1% unemployment rate. The 254,000 number obliterated economists’ expectation of a mere 140,000 jobs and was a far cry from the 159,000 added in August and 144,000 added in July – numbers that had sparked fears that the U.S. economy might be slipping toward a long-feared recession – and that the Fed had waited too long to cut rates.
And while that was followed by a disappointing October jobs report that showed only 12,000 jobs added, that was impacted by both Boeing strikes and the aftermath of a hurricane, leading Wall Street to believe it’s little more than an outlier.
The other development is that inflation continues to moderate, with the October CPI (Consumer Price Index) meeting expectations at 2.6%. That number was reported on November 13 and is being viewed as solid evidence that the Fed remains on the right track.
A month ago, CMEGroup’s trusty FedWatch Tool showed that a majority of industry experts – 56% of them – expected the Fed to slash rates by another 50 basis points, to a 4.00-4.25% range, by the close of the January meeting, signaling fears that the Fed would need to respond to economic speedbumps.
Now, with U.S. economic data remaining strong, expectations are far more modest: only 15% of market participants think 50 basis points in cuts will be needed, while more than 54% think a single cut of 25 basis points will be coming in the next two months.
At the same time, the market is pricing in no expectation of rate hikes at all through the end of this year or through the first quarter of 2025.
In other words, the economy is neither too hot (which could drive inflation) nor too cold (which could require sharper rate cuts), which should be good news for investors.
Again, this is all good news. And in reality, it hasn’t done much to slow the market as a whole – all three major indexes are hovering near all-time highs. But certain pockets of the market have felt the brunt of rising interest rates, and that includes homebuilder stocks, which are down 5.1% in the last month and have really taken on water in the last week as interest rates have spiked to three-month highs.
It won’t last. Whether they slash rates by 25 basis points or 100 in the next couple months, the fact is the Fed is cutting interest rates, and will be doing so for much, if not all, of 2025. And when the federal funds rate falls, so will interest rates and mortgage rates. Even if it takes a little longer than it seemed like it might a month ago.
