The high mortgage rates that have prevented many people from buying homes may not fall quickly, even if President Donald Trump succeeds in appointing a new Federal Reserve chairman who shares his desire to slash the central bank’s target rate.
Trump has reportedly narrowed down the list of possible candidates for Fed Chairman Jerome Powell’s replacement to one person and has hinted that it might be National Economic Council Director Kevin Hassett. Hassett is seen as a candidate who would follow through on Trump’s desire for a lower Fed rate target, which the president has said would help spur homebuying and boost the overall economy.
Nevertheless, while Hassett would likely be able to lower the target rate, he would have only limited influence over the rates that matter the most for households, such as mortgage rates or auto loan rates.
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To adjust monetary policy, the Fed targets very short-term rates in a specific market, namely, for lending between financial institutions overnight.
Longer-term rates, such as those on 30-year fixed-rate mortgages, don’t always move in tandem with the Fed’s target, and since the Fed cut rates last year and this year, they have not.
In fact, if the Fed board becomes too dovish and cuts too much while inflation remains too high, it could cause inflation expectations to surge and have the opposite intended effect on longer-term rates. This could make buying a home even more challenging, according to Desmond Lachman, a senior fellow at the American Enterprise Institute.
Lachman told the Washington Examiner that if Trump picks a very dovish Fed chair who wants to slash the Fed’s target rate aggressively, it could cause long-term interest rates to increase.
“Because what the market is going to say is, ‘Look what this guy is doing, he’s got an expensive fiscal policy, and now he’s got a very easy monetary policy,'” Lachman said. “‘Therefore, if we’re going to be off to the races on inflation, therefore, I can’t accept just getting 4% on my long-term bond. I need to get 5%, I need to get something more.'”
Still, mortgage rates have fallen slightly as the Fed has gradually begun cutting its rate target. However, a massive increase in cuts could have the opposite intended effect.
The Fed is targeting 2% inflation and, according to the most recent reading of the consumer price index, inflation is running a full percentage point higher. All else equal, when the Fed’s rate target is lowered, it can put upward pressure on inflation.
Inflation expectations are also still high, according to the University of Michigan consumer sentiment index for November.
Long-run inflation expectations have softened slightly from 3.9% in October to 3.4% currently, but that is still above the Fed’s goal of 2% long-run inflation.
Meanwhile, mortgage rates are still well above their pre-pandemic levels. As of Tuesday, the average rate on a 30-year, fixed-rate mortgage was at 6.30%, according to Mortgage News Daily. Those same mortgage rates were less than 4% prior to the pandemic.
Mark Hamrick, senior economic analyst at Bankrate, pointed out that the Fed primarily has a lever on short-term rates, while longer-term rates are largely market-driven.
“And so everything from the federal debt to the strength of the economy to the performance of financial markets helps to dictate the level and the direction of long-term rates,” he told the Washington Examiner.
Hamrick noted that the Fed can try to target longer-term interest rates through quantitative easing or quantitative tightening, although he said this is a mechanism that tends to be used in “extreme circumstances,” such as in the aftermath of the financial crisis.
It should also be noted that there is little the Fed chair alone can do to lower or raise interest rates whenever or without consensus.
Instead, that is up to a 12-person board called the Federal Open Market Committee, which consists of the Fed Board of Governors and a rotation of regional Fed presidents. The FOMC collectively decides on the course of interest rate policy. However, the Fed chair can help set the tone and messaging of the central bank.
Lachman said the new Fed chair and existing board will need to resist calls to dramatically reduce the Fed’s rate target, or it could make mortgage rates even worse for homebuyers.
He said that if the Fed were to drastically cut its rate target while inflation is running above the Fed’s 2% target, investors would say: “There’s no way that these guys are going to meet the target. Therefore, I need a higher interest rate to buy United States Treasury bonds, and that then puts the mortgage rates up.”
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The Fed needs to do a balancing act with its rate target, ensuring that it addresses inflation so inflation expectations don’t continue to rise while also ensuring the labor market stays above water.
“I think you need to strike a balance moving forward with long-term thinking in mind,” Rep. Adrian Smith (R-NE) told the Washington Examiner on Tuesday.
