Why the Fed Rate Cut Doesn't Mean What You Think it Does - Seb Frey, Silicon Valley + Bay Area REALTOR

By now you have no doubt heard the news: the Federal Reserve dropped their overnight lending rate by 0.5% (or fifty basis points, as the cool kids say) last week.

The Fed has been teasing a rate cut all year long, although I personally had let go of any expectation that they would actually do so. Inflation remained stubbornly elevated for much of the year, and month after month, the jobs numbers were remarkably strong….leaving the Fed little room to make a cut.

But the weak August jobs numbers, coupled with tamed inflation data, delivered a coordinated one-two punch to Fed policy.

What many had been waiting for all year long (and longer, in many cases) finally came to pass: the Federal Reserve cut the Federal Funds Rate more than most analysts (and armchair observers, like myself) had been anticipating.

My social media feed – filled with REALTORs and mortgage lenders – lit up like a Christmas tree! Angels were singing, the birds were chirping, the clouds parted and the sun shone brightly on the blighted lands below. Hallelujah, the good times are coming, we are free at last!

Predictably, many are saying that the Fed rate cut will usher in a decrease in mortgage rates…which will in turn lead to rising home prices.

For better or worse, it doesn’t actually work like that. And it’s easy to see how fallacious that notion is: mortgage rates skyrocketed in the spring of 2022, which many were predicting would lead to a home price crash…that never materialized. True, prices dipped, for a time – but then they continued marching right up again, setting a new all-time pricing high in Silicon Valley this year, in the face of 7-plus percent interest rates.

The fact is, there is very little correlation between mortgage rates and home prices. And actually, there is very little correlation between the Federal Reserve’s benchmark Federal funds rate and mortgage rates.

Mortgage rates are much more closely linked to bond yield rates – which are affected by many factors, and only one of those is the Federal funds rate.

Mortgage rates have gone down – the average 30-year fixed rate mortgage rate is presently around 6.17%, which is the lowest it’s been in about 18 months. But rates have been falling for some time, tracking the decrease in bond yield rates, which have been dropping for the past six months or so.

And mortgage rates will likely decline further still – because bond yield rates will likely continue to decline for some time to come.

But I caution anyone against expecting that this will mean home prices will surge. That’s because what really drives home prices is the delicate balance between supply and demand, not mortgage rates.

Yes, lower rates do make mortgages more affordable, which should juice demand.

But haven’t we been hearing for years now that the supply crunch is due to homeowners “locked in,” not wanting to sell due to their low mortgage rates? And that if rates are now lower, and they think buyers will be primed to pay more given that they can better afford higher loan amounts, that the time has finally come to pull the trigger and sell their home?

In other words, might we not see increased supply to meet this widely anticipated stronger demand?

Who knows? Classic Keynesian economics says that is exactly what should happen. If supply does open up, it’s unlikely we’ll see much of an increase in prices whatsoever. If supply fails to meet a jump in demand, then yes, we can expect prices to rise.

As should now be clear, I’m not expecting the Fed rate cut to have any significant impact on today’s real estate market.

But what about tomorrow’s real estate market?

To me, the biggest thing the rate cut will accomplish, as it relates to the real estate market, is that it injects a sense of optimism – that the market will start moving again. Even though it won’t affect mortgage rates much, or cause prices to soar, the fact that people think that’s what will happen should help get both buyers off the fence and into the market, creating more opportunity for all.