As expected, the Federal Reserve raised the federal funds interest rate by 0.75% for a third consecutive time. The key rate, which was cut to 0% at the beginning of the pandemic, will now float between 3% to 3.25%.
The stock market will feel the impact in the short term while the housing market may feel it for the foreseeable future.
The Fed policymakers are hiking interest rates in a bid to reduce inflation. The federal funds rate directly affects things like the interest rate on credit cards and on auto loans. While it doesn’t directly affect mortgage rates, the Fed’s most recent hikes have contributed to the near doubling of interest rates paid by homebuyers.
How mortgage rates are affected
The 30-year fixed-rate mortgage goes up and down with the yield on the Treasury Department’s 10-year bond. The Fed’s policy of trying to slow the economy has reduced the number of buyers of U.S. bonds. Fewer buyers mean the government has to pay a higher interest rate to remain competitive.
Early in the pandemic, the yield on the 10-year bond was below 1%, producing record-low mortgage rates. The yield is now about 3.5% and may rise further as the Fed continues its efforts to slow the economy.
The rapid rise in mortgage rates has already had a major impact on the housing market. On the day the Fed announced its latest rate hike, the National Association of Realtors (NAR) reported existing home sales fell another 0.4% in August. No doubt to the Fed’s satisfaction, the median home sale price fell to $389,500 – down from June’s record $413,800.
"The housing sector is the most sensitive to and experiences the most immediate impacts from the Federal Reserve's interest rate policy changes," said NAR Chief Economist Lawrence Yun. "The softness in home sales reflects this year's escalating mortgage rates."
Fewer sales often mean home prices will fall but in this case, price reductions might be limited. NAR reports the number of available homes for sale in August was 1.5% lower than in July and about the same as in August 2021.
Stocks slump
The stock market has consistently fallen from its record high as the Fed has increased interest rates this year and after an initial short rally Wednesday, the Dow Jones Industrial Average fell 522 points, even though the market fully expected the 0.75% rate hike.
Since most corporations borrow money, higher rates can reduce profit margins. Companies that are growing but not yet profitable feel the greatest impact of higher interest rates.
Investors may have hoped for any slight sign that Federal Reserve Chairman Jerome Powell and the rest of the Federal Open Market Committee (FOMC) were considering a pause in their campaign to slow the economy. They didn’t get it.
“My main message has not changed,” Powell told reporters after the Fed meeting “The FOMC is strongly resolved to bring inflation down to 2%, and we will keep at it until the job is done.”