The Future of Interest Rates

The Fed has expected raised short-term rates, the Fed Funds Rate, by ¼% last week to 2.25%. The Prime Rate which affects home equity loans, car loans, and credit cards is now 5.25%. Fed Chair Powell said, “Inflation is low and stable. We don’t see any surprises to the upside.  We don’t see that, it’s not in our forecasts.” Within the Statement, the Fed upped its numbers for economic growth (GDP) and also revealed a tame inflation outlook through 2021.

 

The Fed also revealed its Dots Chart on where its members see short-term rates in the future. 12 of their 16 members are predicting there will be another ¼% rate increase this year, probably in December. 9 of the 16 members expect the Fed Funds Rate will be at least 1% higher than today at 3.25% as of December 2019. 13 of the 16 members expect that the Fed Funds Rate will be at least .75% higher or at 3% by end of next year. I agree that short-term rates will be at least 3% a year from now.

 

So, what does this mean for mortgage rates? If mortgage rates move in tandem with the Fed Funds Rate I would expect mortgage rates to be in the upper 5’s to near 6% by the end of next year. But, let’s look at history. In December 2016 the Fed raised the Fed Funds Rate to 0.75% and mortgage rates averaged 4.20% as long-term rates soared after the Presidential election.

 

Since December 2016 the Fed has raised short-term rates by 1.5% to 2.25% and mortgage rates are up only about .75% as the Fed was incredibly slow in raising short-term rates under Janet Yellen. So, the Fed has been catching up with the bond market. Will short-term rates continue to increase faster than long-term rates?

 

My answer is it depends…on the rate of inflation as measured by the Core PCE. I believe mortgage rates will increase if this measure of inflation increases too. I believe this is the best predictor of mortgage rates for the next year.

 

However, if the Fed’s prediction of low inflation continues we may not see long-term rates rise that much as long-term bond investors will believe that the Fed has inflation fully under control. Still, I expect that mortgage rates will be at least 5.50% by this time next year.