The Fed's Rate and the Bond Market
The FOMC's target band for the federal funds rate sits at 3.50% to 3.75%, and the effective rate has been trading at 3.63%, within that band. This is the rate banks charge one another for overnight loans. Separately, the 10-year Treasury yield climbed to 5.041% on Tuesday, the loftiest reading since 2007, as traders positioned for the Fed to raise rates.[S1]
Thirty-year home loans track the long end of the bond market. Their pricing derives from agency mortgage-backed securities—pools of mortgages sold to investors—and the Fed has described the yields on those securities as a key input in determining mortgage rates. These securities also trade at a spread above longer-maturity Treasurys.[S1]
Inflation Credibility and Long-Term Yields
Yields on longer-dated debt, which represent investor returns, are shaped by what markets expect for future real short-term rates and inflation, along with a term premium—the extra compensation investors require for the risk of holding longer-duration debt. Economic growth, government borrowing supply, and appetite for risk can each shift those components.[S1]
A number of analysts argue that lifting rates by a quarter point could bolster the Fed's credibility on inflation and could take some of the upward pressure off long-term yields, which might work in homebuyers' favor.[S1]
Historical Patterns and Alternative Explanations
Jim Reid, Deutsche Bank's global head of macro research, has published analysis indicating that once a hiking cycle gets under way, 10-year yields have generally climbed, gaining an average of about 1.14 percentage points over the ensuing 12 months.[S1]
On Friday the 10-year inflation-protected yield was 2.60%, while the nominal 10-year stood at 4.96%, a gap that implies 2.36 percentage points of inflation compensation. In its July report to Congress, the Fed concluded that longer-run inflation expectations remain well anchored.[S1]
What It Means for Homebuyers
No matter what the Fed decides on Wednesday, no one should promise a homebuyer that it will lower their mortgage costs. Still, comparing a hike that markets have already absorbed with a pause that they have not, it is the choice to leave rates alone that poses the bigger danger of driving long-term yields—and therefore mortgage costs—upward.[S1]
