Fed policy is set to change. How will mortgage rates respond?

Federal Reserve policymakers are expected to lower the benchmark interest rate on Wednesday for the first time in more than four years. But it appears to be anyone’s guess as to how large the cut will be.

Interest rate traders were giving shorter odds on Tuesday afternoon to a cut of 50 basis points (bps), which would trim the Fed’s target range to 4.75% to 5%. According to the CME Group‘s FedWatch tool, 63% of traders expect rates to be dialed back by 50 bps, while 37% call for a cut of 25 bps.

Market observers, including several economists, have taken note of the recently rising optimism for a larger rate cut.

“After holding steady for over a year, the Fed is ready to cut rates this week. However, the lead up to this meeting is proving to be curious,“ Emily Overton, a capital markets analyst for Veterans United Home Loans, said in a statement.

“Markets have suddenly flipped their expectations from 25 bps to a 50 bps cut without any large data release as the catalyst. We could very well see 50 bps as the first cut. Federal Reserve Chairman Jerome Powell has shown concern over the labor market and doesn’t appear to welcome any further easing. The revised dot plot will most likely show more easing for this year, averaging 50 to 75 bps.“

Mortgage rates, which aren’t directly impacted by overnight interest rates, have nonetheless moved lower in recent months. At HousingWire‘s Mortgage Rates Center on Tuesday, the average rate for a 30-year conforming loan was 6.34%. That figure was down 13 bps from a week ago and 26 bps lower than two weeks ago.

“The recent decline in mortgage rates is contributing to the momentum toward normalization and unleashing the housing market potential in the next few years,“ CoreLogic chief economist Selma Hepp said. “About 4 million homes have a refinance opportunity with rates falling closer to 6% and there are more in the pipeline as the Fed starts the easing cycle.

“It’s important to note that lower rates have been a hot topic for a while, and potential homebuyers have been on the sidelines in anticipation of lower rates and improved affordability.“

Fannie Mae economists recently projected a total of 5.19 million home sales for next year. That figure that was lower than a previous estimate but still higher than the 4.78 million sales that are expected in 2024.

Long-awaited rumors of a U.S. recession have yet to materialize, although the economy has slowed considerably in 2024. The nation added 142,000 jobs last month, well below the monthly average of 202,000 for the past year, and figures for both June and July received significant downward revisions. Meanwhile, the unemployment rate has grown to 4.2% after reaching 3.4% in April 2023.

“The soft landing is working, and the Fed is looking to stimulate housing while the economy is still somewhat in a good spot in terms of inflation and consumer confidence,“ said Charles Williams, CEO of Percy.ai. “They will need to lower rates more to create a mini refinance boom, and builders are now constructing more starter homes. So, with additional rate cuts coming later this year, 2025 will see a housing market rebound in both existing and new home sales.”

Sam Williamson, senior economist for First American, believes that while the Federal Open Market Committee (FOMC) may discuss a 50-bps cut on Wednesday, “it’s unlikely because the Fed wants to avoid conveying a sense of alarm or signaling they may be behind the curve in cutting rates.“

Results from a Reuters poll show that a majority of analysts expect the Fed to make three rate cuts totaling 75 bps by the end of 2024. Depending on the FOMC’s actions on Wednesday, Williamson said that investors could begin to “recalibrate their expectations“ by pricing in fewer cuts, which could lead to higher Treasury yields and mortgage rates in the short term.