Why Mortgage Rates Remain High Despite Fed Rate Cuts and Lower Inflation
Mortgage rates have become one of the most scrutinized and misunderstood forces in today’s economy. Despite multiple rate cuts by the Federal Reserve and inflation dropping significantly, mortgage rates remain stubbornly elevated, frustrating homebuyers and industry professionals alike. To understand why this is happening, we need to understand what actually drives mortgage rates and what other factors at play besides the Fed and inflation.
Let's begin with a bit of recent financial history to help illustrate what influences mortgage rates and why we've seen such dramatic swings over the past several years.
As we saw during the Great Recession in 2009, and similarly at the onset of the COVID pandemic in 2020, the Federal Reserve employs a strategy called Quantitative Easing (“QE”) in times of economic distress in the United States. QE involves the Fed purchasing massive amounts of financial assets, and most importantly for mortgage rates, mortgage-backed securities (MBS). Mortgage-backed Securities are basically a bundle of mortgage loans packaged into a single asset and sold to investors. These investors range from large institutions like banks, pension funds, insurance companies, and notably the Fed itself, to individual investors who typically invest through retirement accounts like 401(k)s or IRAs. Mortgage-backed Securities and U.S. Treasury bonds are attractive to investors because they provide stable returns and offer a relatively safer investment option compared to riskier investments like stocks, especially in times of economic distress or uncertainty.
During periods of QE, when the Fed enters the market as a buyer of these mortgage-backed securities, it creates significant and unnatural demand, which forces the price of MBS up and consequently drives interest rates down. This phenomenon follows the basic law of supply and demand: more buying means higher prices, which in relation to mortgage rates is equivalent to lower discount fees, which leads to lower yields, or in the case of mortgages, lower interest rates. That is precisely how mortgage rates fell to historic lows during the height of COVID—not because of fed rates or inflation or anything else, but due to the Fed artificially inflating demand through its aggressive MBS purchases, to the tune of hundreds of billions of dollars.
This changed dramatically beginning in November 2021, when the Fed announced plans to reduce its purchases, effectively winding down its QE program. By March 2022, QE ended completely. Then, starting in June 2022, the Fed began Quantitative Tightening (QT), allowing many of the mortgage bonds on its balance sheet to mature without reinvesting the proceeds. In other words, when these mortgage bonds were paid off, the Fed simply held onto the cash rather than reinvesting it into new mortgages. This reduction of reinvestment eliminated the artificial demand that had supported low mortgage rates, forcing the market to rely on normal investor demand once again.
Unfortunately, the economic conditions were anything but normal when the Fed turned off the gravy train. Normally, banks might have stepped up to fill the demand gap by purchasing more mortgage-backed securities, but they didn’t. Why not? Because along with the Fed, many banks bought large amounts of U.S. Treasury bonds and Mortgage-backed securities at very low interest rates during the pandemic. As rates climbed back up after the Fed ended QE and began QT, the value of these lower-yielding bonds plummeted. The reason for this is simple but rarely understood: if a bank invested in a $500,000 bond paying a 3% annual yield ($15,000 per year), but later interest rates rose to 6%, investors could achieve that same $15,000 annual return by investing only $250,000—effectively cutting the market value of the original 3% bond in half. Unless a bank was willing to accept and realize these substantial losses, these investments became essentially illiquid. (Note: This simplified example illustrates how bond market values decrease when new bonds are issued at higher yields. In practice, precise bond valuations involve additional complexities such as bond duration, coupon timing, and market liquidity.)
These realities became painfully clear after the illiquidity of these bonds played a big part in the collapse of several regional banks in 2023. Following these events, banks grew increasingly cautious, holding onto their cash rather than reinvesting in mortgage-backed securities, further driving down demand thus driving up mortgage rates.
Now, let’s discuss the influence of inflation and Fed rate hikes (or cuts) in relation to mortgage rates.
Simply put, rising inflation results in rising rates. When inflation exceeds a bond's interest rate, investors effectively lose money because their investment returns can't keep pace with rising prices. As inflation soared to the highest levels in over 40 years, bonds offering relatively low returns became far less attractive, sharply reducing investor demand for bonds and mortgage-backed securities (MBS).
In response to raging and persistent inflation, the Fed aggressively increased the Fed Funds rate to regain control. Raising this rate makes short-term borrowing more expensive, resulting in consumers facing higher interest rates on credit cards, auto loans, and home equity lines of credit (HELOCs), causing them to spend less. Simultaneously, businesses encounter higher borrowing costs, slowing their growth and hiring. Collectively, these actions intentionally slow economic activity, reducing demand and helping bring inflation down.
This approach worked exactly as intended. Inflation cooled significantly, allowing the Fed to pause rate hikes and eventually begin a series of rate cuts. Nearly everyone from industry professionals to homebuyers expected mortgage rates to drop accordingly. Yet mortgage rates have remained stubbornly elevated, even increasing in some cases. Why?
While Fed rate hikes or cuts often coincide with movements in mortgage rates, it's crucial to understand that the Fed Funds rate itself doesn't directly set mortgage rates. Instead, mortgage rates primarily depend on investor expectations and their demand for safer assets, like mortgage-backed securities. In today's environment, persistent inflation (still above the Fed’s 2% target), ongoing uncertainty surrounding bank balance sheets, and the Fed’s continued emphasis on a resilient U.S. economy have significantly reduced investor demand for these mortgage-backed assets. As a result, mortgage rates remain elevated despite recent Fed rate cuts and substantially lower inflation.
So where does that leave us? Let’s take a careful look at what's happening right now, and how these factors could shape mortgage rates in the months and years ahead.
Despite the Federal Reserve’s optimism about inflation cooling down and the economy staying strong, signs of stress are beginning to show. The Fed might have gone too far by keeping interest rates high for too long. If rates stay too high for too long, it can unintentionally slow down the economy more than intended and trigger a recession.
Until recently, most experts believed a recession was unlikely, but new data suggests there might be some hidden problems beneath the surface. One important issue is the true health of the job market. On the surface, employment reports look strong, and headlines often highlight low unemployment numbers. But a closer look at the numbers shows some troubling trends: more and more people are filing unemployment claims, and job reports are frequently being revised downward, revealing that fewer jobs were actually created than originally reported.
Another major concern is emerging in commercial real estate. Over the next several years, trillions of dollars in commercial loans on apartments, office buildings, retail stores, warehouses, and other properties will need refinancing at today’s significantly higher interest rates. Commercial property values depend largely on the income they produce, and higher interest rates mean higher loan payments—directly reducing net operating income and, consequently, property values. Unfortunately, many commercial properties still aren't generating enough rental income to cover these increased payments, partly due to lasting impacts from the COVID pandemic. Changes such as widespread remote work reducing office occupancy, shifts in consumer shopping behavior affecting retail spaces, and persistent economic uncertainty have put continued financial strain on commercial property owners. This has left many with properties worth less than what they owe, unable to refinance or repay existing loans, placing the banks holding these loans at significant risk. Without careful intervention, this situation could escalate into a financial crisis reminiscent of 2008, though this time centered around commercial rather than residential real estate.
Compounding these concerns is ongoing political uncertainty, including trade tensions, immigration policy shifts, and the substantial volume of U.S. government debt refinancing approaching over the next few years. While these political issues do not directly influence mortgage rates, the resulting market volatility and investor caution indirectly reduce demand for risk-sensitive assets like mortgage-backed securities, exerting upward pressure on mortgage rates.
This volatile combination of political and economic uncertainty has already triggered dramatic swings in financial markets. Recently, the stock market has experienced massive fluctuations, with trillions of dollars gained or lost in a single day. Part of this volatility has been driven by margin calls—situations in which investors who had taken extremely leveraged positions were forced to quickly sell large amounts of assets to avoid catastrophic losses. These forced sales not only exposed the risks taken by certain investors but also added to broader market instability. Although it remains difficult to predict exactly how these events will unfold, the ongoing volatility significantly raises the likelihood of tipping the economy into a recession.
Also on the horizon is the potential privatization or reduction of government backing for Fannie Mae and Freddie Mac. Currently, these government-sponsored entities help finance most U.S. mortgages, giving investors’ confidence that these mortgage-backed securities are relatively safe. Should this government support diminish, investors might view mortgage bonds as riskier, reducing demand even further and putting additional upward pressure on mortgage rates, regardless of Fed actions.
Fortunately, the current administration recognizes the critical importance of housing affordability. Recent positive policy shifts—such as reducing tariffs on lumber to make homebuilding cheaper and easier—demonstrate their awareness of housing market stability. These actions suggest policymakers will likely avoid drastic decisions that could exacerbate the existing market stress.
Regardless of how these political and economic factors develop, one fact is clear: interest rates need to come down significantly. Between now and 2027, over $10 trillion in debt across the U.S. economy (including government borrowing, corporate loans, commercial real estate, and consumer debt) will need to be refinanced. Most of this debt was originally taken out when interest rates were much lower than they are today. Refinancing at current, higher rates would put enormous financial pressure on everyone involved, creating intense urgency for interest rates, including mortgage rates, to drop.
Recent economic reports indicate that growth has already slowed considerably in early 2024, suggesting we may soon face, or perhaps have already entered, a recession. While recessions come with economic challenges, there is an important silver lining: historically, recessions have driven mortgage rates substantially lower, typically resulting in about a 35% drop from peak levels. If history repeats itself, mortgage rates could realistically decline below 5%, or possibly even lower.
Additionally, despite what some suggest, recessions rarely lead to a significant drop in home values. Housing inventory nationwide remains historically low, with a substantial pool of potential buyers eagerly awaiting lower mortgage rates. Some predict lower mortgage rates could prompt more homeowners to list properties, increasing inventory and potentially slowing price growth. However, this scenario is unlikely to substantially alter housing supply, as most sellers immediately become buyers themselves (upgrading, downsizing, or relocating).
While some additional inventory might come from investors liquidating properties or older homeowners downsizing without repurchasing, these cases likely won't create enough supply to meaningfully impact overall housing availability. Moreover, although a recession could reduce purchasing power for some buyers, today's market contains a large segment of financially stable buyers with substantial equity, who will likely continue to move regardless of broader economic conditions. As a result, any significant mortgage rate decline triggered by a recession may quickly reignite home price appreciation, potentially offsetting short-term affordability gains.
Ultimately, mortgage rates depend on a complex combination of economic conditions, investor behavior, and political decisions—factors extending well beyond the actions of the Federal Reserve or inflation alone. Understanding this broader context helps explain why mortgage rates remain high today and provides valuable insight into what might happen next, both for mortgage rates and for the residential housing market as a whole.
The insights and analysis presented here are informed by my comprehensive tracking and analysis of economic data, financial market trends, and policy developments from multiple sources over an extended period. This article reflects my personal opinions and does not represent the views of CrossCountry Mortgage or any other company I represent.Don’t worry about sounding professional. Sound like you. There are over 1.5 billion websites out there, but your story is what’s going to separate this one from the rest. If you read the words back and don’t hear your own voice in your head, that’s a good sign you still have more work to do.
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