Fed's 'skip' points to slower hikes, a longer wait for shift in rates

The Federal Open Market Committee on Wednesday finally paused its short-term rate hikes, but indicated this is unlikely to mean an end to rising financing costs that have put pressure on the housing finance industry and the larger market with the intent of quelling inflation.

Federal Reserve Chairman Jerome Powell indicated during a press conference Wednesday afternoon that the hiatus reflects the fact that "inflation has moderated somewhat," but noted that at 4%, it has a ways to go to meet its 2% target. So more hikes are likely.

"It may make sense for rates to move higher, but at a more moderate pace," he said.

While the short-term rates the Fed holds sway over don't always move in tandem with the long-term financing that currently dominates the mortgage market, there was some consensus that the pause in the former makes a large, near-term or sustained decline in the latter unlikely. 

(The Fed on Wednesday made no change to policies around its mortgage-backed securities holdings, which can have more direct influence on housing finance rates.)

"I don't think we'll see a big drop in mortgage rates unless inflation makes significant progress toward the Fed's target or there's a decline in economic activity that signals a recession," First American Deputy Chief Economist Odeta Kushi said in an interview.

The fact that the Fed made it clear that officials weren't expecting to sustain the pause suggests lenders who were initially hopeful it could signal the arrival of a favorable shift in the mortgage rate cycle might have to wait a little longer.

"A skip foretells the intent of future raises and this should be characterized as a skip," said Daniel Jacobs, managing director at TruLoan Mortgage, in an interview. "For mortgage rates, I read this as we're going to have a longer slower path to a declining rate environment. It's going to happen but the timing is unpredictable."

More moderation would be in line with reduction in the size of hikes in the past year. That's tempered upward pressure on the average Freddie Mac mortgage rate, which has fallen a little from its peak above 7% last year, but housing finance costs have generally remained above 6%. 

So although there was hope the recent two-year low in inflation could drop rates even further ahead of the Fed's decision, until monetary policy officials look likely to allow for more than a month's hiatus, whether there'll be any significant decline in financing costs remains unclear.

Meanwhile, even with rates lower than their '22 peak, mortgage and housing industries — which Fed officials have said they've been waiting to show signs of a correction in before they relent — have seen financing costs dampen demand.

At current rates, demand for homes has become lackluster and based on the extent of permanent buydowns builders have found they need to revive interest, it looks like financing costs would have to fall back to 5.5% to 6% for activity in the originations and the housing to rise.

"Listening to a lot of the homebuilders talk on their quarterly calls, that rate buydown is really helping out a lot in terms of affordability," said Robert Rulla, a senior director at Fitch Ratings corporate finance group who focuses on homebuilding and related materials, in an interview.

The two things likely to drive a rise in consumer interest based on affordability would be rates falling to a sweet spot for demand builders have discovered between 5.5% and 6% or lower home prices.

Generally builders have declined to discount homes so far, he said, adding that there are variations in that and the extent to whether or not buydowns are offered depending on the supply and demand conditions in each local market. 

But if monetary policy were to become more predictable and rates were to stabilize from here, demand could improve among consumers who aren't hindered by affordability.

"If rates remain the same, people may not … continue to wait to move," Michelle Raneiri, vice president of U.S. research and consulting at TransUnion, in an interview, noting that on a historical basis, mortgage rates are still favorable and near their long-term average.

However, generally some loan products will likely continue doing better than others if the status quo persists.

"Cash-out refis, we're still not seeing many of those because people have lower rates that they bought their houses at in the last several years," she said. However people in the latter category may show sustained demand for home equity products and the level in their houses is high.

Powell acknowledged that some of the correction in housing prices the Fed has been looking for has materialized during his press conference Wednesday but indicated that he is looking to see more, particularly in the rental sector.

"I don't know that housing itself is going to be driving the rate picture but it's part of it," he said.

The Fed will likely pay closer attention to what the consumer does overall, said Nick Smith, managing partner and CEO of Rice Park Capital Management, noting that to some degree its hawkish tone is an attempt to get the market to be less optimistic and lower inflation.

"So long as people have jobs and are confident they'll spend money and the economy will do well. I think they want to shake that confidence and if that happens, that'll be a really clear signal the Fed can take their foot off the brake," he said.