The Fed raised interest rates last week and signaled a faster path of hikes in 2017 and 2018. The banking sector’s prime rate went up immediately, and mortgage rates could soon follow.
Upward pressure on U.S. mortgage rates could be just getting started now that the Federal Reserve has raised interest rates and signaled a more aggressive path of hikes over the next two years.
The federal funds rate, a benchmark interest rate that determines how much it costs for banks to lend to each other, rose by 25 basis points last week to a new target of 0.5% to 0.75%. It was the first increase in 2016 and only the second adjustment since 2006. The move was accompanied by a more hawkish outlook, with Fed officials now predicting three rate increases in each of the next two years, bringing the target for the federal funds rate back in line with the long-run average above 3%.
At the outset, it should be noted that the Fed is notoriously bad at predicting interest rates. This time last year, the central bank forecast four rate increases in 2016. Only one materialized. The delay was due to recurring fears about the health of the U.S. economy during a dismal first half of the year. The economy has accelerated over the past six months, with gross domestic product (GDP) expanding at an annualized 3.2% in the third quarter. That was the fastest in two years.
This time, however, market participants are more likely to believe the central bank’s guidance. For starters, the economy is already at full employment by the Fed’s standards, and is still adding jobs at a robust pace. Secondly, and perhaps most importantly, inflationary pressures are strengthening. This is true both with respect to core personal consumption expenditures and average hourly wages.
Inflation expectations are also on the rise in the wake of Donald Trump’s election victory. The President-elect supports policies that could lead to faster inflation, which could prompt the Fed to tighten policy more aggressively.
The Fed’s rate hike last week had an immediate effect. U.S. lenders. J.P. Morgan Chase & Co, Bank of America Corp and Wells Fargo & Co have already raised their prime rate to 3.75% from 3.5%. The prime rate is a reference point for a variety of loans, including credit card debt.
The Mortgage Bankers’ Association (MBA) says the Fed’s new outlook could influence mortgage rates sooner than previously expected as lenders pass on higher costs to consumers. Thirty-year fixed-rate mortgages have been on the rise since the U.S. election, hitting a more than two-year high of 4.16% last week, according to Freddie Mac. That was the tenth consecutive weekly rise.
Freddie Mac also said the average 15-year fixed-rate mortgage crept up to 3.37% in the week ended December 15. Five-year Treasury indexed hybrid adjustable-rate mortgages, which are more sensitive to Fed moves, averaged 3.19% in the latest week.
Interest rates remain very low by historical standards and the Fed’s outlook suggests stronger economic growth will offset the immediate impact of higher borrowing costs. During the tail end of the last housing bubble, the federal funds rate was above 5%.
Market participants expect the federal funds rates to rise again in June, according to the CME Group’s FedWatch Tool. However, the federal funds rate has been notoriously difficult to predict over longer-term horizons. The central bank has adopted a wait-and-see approach, clouding investors’ outlook on the exact pace and timing of future adjustments.
 Harriet Torry (December 15, 2016). “Fed Raises Rates for Frist Time in 2016, Anticipates 3 Increases in 2017.” The Wall Street Journal.
 Freddie Mac. Mortgage Rate Survey Archive.
 Julia Chang (December 14, 2016). “What The Federal Reserve Interest Rate Really Means For Your Money.” Forbes.