The Fed is about to cut interest rates. Here's what that means for mortgages.

By Aarthi Swaminathan

Mortgage rates typically fall in advance of a Fed rate cut 'because investors are trying to anticipate where the Fed will go.'

With the Federal Reserve widely expected to cut interest rates next week, the housing market is saying goodbye to 7% mortgage rates and rock-bottom home sales.

Recent data showing that the U.S. job market is slowing and inflation is cooling have provided evidence to the Federal Reserve that it can cut its benchmark interest rate. The Fed started ramping up interest rates in 2022, in an effort to arrest inflation in the economy.

The housing market, one of the most rate-sensitive sectors in the U.S. economy, has directly felt the impact of the Fed's rate hikes. Over the last two years, higher interest rates have thrown cold water on the housing market. Home sales have plunged, with home buyers pulling back in the face of high borrowing costs and soaring home prices. Mortgage rates hit their highest level in two decades, briefly touching 8% last October.

Since then, the U.S. economy has slowed down and inflation has moderated, putting the Fed on the path toward rate cuts. Financial markets now expect a rate cut in the magnitude of 25 basis points at the Fed's next meeting on Sept. 17-18 - and that assumption had already been reflected in mortgage rates as of Sept. 6, according to the Mortgage Bankers Association, when the 30-year fixed mortgage rate was averaging 6.29%, the lowest level since February 2023.

Mortgage rates typically fall in advance of an actual Fed rate cut "because investors are trying to anticipate where the Fed will go," Danielle Hale, chief economist at Realtor.com, previously told MarketWatch. (Realtor.com is operated by News Corp subsidiary Move Inc. MarketWatch publisher Dow Jones is also a subsidiary of News Corp.)

So when economic indicators such as the August jobs report indicated that the labor market was cooling, mortgage markets reacted immediately, pushing rates down in anticipation of the Fed slashing rates in the near future.

Likewise, when Wednesday's consumer-price index report showed that inflation had cooled in August and was closer to the central bank's 2% goal, mortgage rates fell again by 11 basis points, according to Mortgage News Daily.

See also: A record share of Americans expect mortgage rates to fall over the next 12 months. How low will rates go?

The inflation data "is one of the last major data checkpoints on the road to the Fed's meeting and decision in September," Hale said on Wednesday. "It holds vital clues about the likely size of the Fed's cut in September, which is widely believed to be a given, at this point. In my view, the continued decline in August inflation solidifies the path for a rate cut in September."

The way the markets have already priced in a rate cut "is pretty significant" and consumers "should be feeling it already," Kathy Bostjancic, chief economist at Nationwide Mutual, told MarketWatch.

At the same time, people looking to buy a home shouldn't expect mortgage rates to fall much further from here on out, one economist advised.

Because the impact of Fed rate cuts "has already been largely baked into mortgage rates," anyone expecting mortgage rates to "drop dramatically after the Fed cuts rates will be disappointed," said Lisa Sturtevant, chief economist at Bright MLS.

And ultimately, home buyers should not feel compelled to buy or hold off on a purchase based on how mortgage rates are trending, Leo Pareja, chief executive of real-estate brokerage eXp Realty, told MarketWatch.

"I don't know a single person who's woken up and gone, 'Rates are perfect today. It's 2.85%, honey. Let's go shopping.' It's more like, 'You know, we need another room for your parents, [or] we need another room for our kid,'" he said. "Those are the triggers, and you make a financial decision based on what you can afford."

Read more: Jittery home buyers want the election to be over before they make their move. 'Nobody knows what's going to happen.'

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-Aarthi Swaminathan

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09-12-24 1013ET

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