Fed announces big rate cut

The Federal Reserve has cut its funds rate by 50 basis points, lowering interest rates for the first time in more than four years amid signs of a slowing economy and cooling inflation.

The central bank said on Wednesday afternoon it was reducing its key rate to a target of 4.75% to 5.0% at the conclusion of its scheduled deliberation on interest rates.

A cut had been widely anticipated by market watchers – but the size of the reduction, larger than the 25-basis-point drop many had expected, sees the Fed stamp its intention to arrest the labor market’s growing sluggishness.

Decisionmakers opted to introduce a so-called jumbo cut as the opening salvo of what’s expected to be a series of moves to bring rates lower in the months ahead.

The decision is the first time since March 2020 that the Fed has decided to cut rates at the conclusion of a FOMC (Federal Open Market Committee) meeting.  

The central bank slashed rates by a total of 150 basis points that month in response to the rapidly escalating economic crisis posed by the arrival of COVID-19 in the US.

It kept rates resolutely low for the next two years but began a series of aggressive rate hikes in March 2022 as inflation spiraled alarmingly upwards.

Yearly consumer price index (CPI) inflation spiked to 9.1% in June of that year – but the Fed’s spate of rate jumps appears to have played its part in cooling price growth, with the annual figure retreating to 2.5% at last reading.

Slowing labor market, worsening economic outlook spur Fed decision

While the labor market showed plenty of resilience in the opening months of 2024, its progress has finally slowed in the face of climbing interest rates. The Bureau of Labor Statistics said at the beginning of September that the three-month average in nonfarm payroll growth had hit its lowest level for over four years.

The national unemployment rate dipped in August for the first time in five months – but Mortgage Bankers Association (MBA) senior vice president and chief economist Mike Fratantoni highlighted that it’s likely to remain elevated over the next year, and potentially reach 5%.

Fed chair Jerome Powell opened the door to rate cuts at the central bank’s annual conference in Jackson Hole, Wyoming last month, signaling that “the time has come” for rates to start falling against the backdrop of a darkening economic outlook.

While the Fed is clearly alert to the possibility of a further downturn for the economy, confidence remains high that the central bank can achieve a so-called “soft landing” – a return to target inflation without triggering a recession.

A strong majority of respondents to a CNBC Fed Survey in advance of today’s decision suggested the Fed was on course to succeed in that goal: seventy-four percent (74%) said it was cutting in time to preserve a soft landing, with just 15% believing it was too late and 11% suggesting it was too early, risking a potential resurgence in inflation.

How will the mortgage market react to the Fed cut?

Mortgage rates have slid in recent weeks, falling below the 7% mark and providing welcome relief to homebuyers and owners grappling with high borrowing costs.

Still, those rates are unlikely to dip significantly in the immediate aftermath of today’s Fed announcement – namely because bond yields, which are often impacted by Fed decisions, were already pricing in a likely rate cut.

First American senior economist Sam Williamson suggested mortgage rates could briefly rise following the latest decision. “Should investors recalibrate their expectations after the September FOMC meeting for fewer cuts this year than currently anticipated, we may see Treasury yields, and consequently mortgage rates, rise in the short term,” he wrote. “In the medium term, we anticipate further, though gradual, declines in mortgage rates.”

Two further Fed rate decisions are penciled in for the remainder of the year: one on November 6-7, and the last on December 17-18.

Cuts are expected at each of those meetings, although Williamson cautioned that mortgage rates were unlikely to move low enough by the end of 2024 to spark a big uptick in homebuying activity.

That’s because the so-called “lock-in” effect, which is seeing scores of homeowners remain in their current property instead of deciding to move elsewhere because of their current advantageous interest rate, is unlikely to shift before the end of the year. “Lower mortgage rates might stimulate demand more than it increases supply,” Williamson said.

“Historically, existing-home inventory has constituted the majority of total inventory, and about 86% of current homeowners have a mortgage rate below 6%. Therefore, even if mortgage rates gradually decline through the rest of the year, they are unlikely to decrease sufficiently to ‘unlock’ the majority of these homeowners.”

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