When the Federal Reserve raises or lowers its benchmark interest rate, many people expect mortgage rates to follow suit. But the relationship isn’t that straightforward.
The federal funds rate—the rate banks charge each other for overnight loans—has an indirect impact on mortgage rates. The Federal Reserve sets a target rate range for its rate—currently 4.25% to 4.5%—to implement its monetary policy.
But contrary to popular belief, mortgage rates don’t always track the same path as the Fed rate. And even though the Fed’s rate decisions indirectly influence mortgage rates, there are many other factors at play.
That’s because the Federal Reserve bases its rate decisions on economic data and its dual mandate to control inflation and ensure a stable job market. And mortgage rates play by a different set of rules.
Here’s what moves mortgage rates
While Fed rate decisions capture the headlines and sway markets, homebuyers should watch the 10-year Treasury yield for better insight into potential mortgage rate changes, said Mark Fleming, chief economist with First American Financial Corporation.
“There’s a lot of uncertainty around future economic policy, fiscal policy, as well as non-economic policies by the government that could further drive up long-term rates,” Fleming said, adding that investors are reading the temperature of the new administration’s policies and seeing inflationary pressures ahead, creating more risk.
When the Fed adjusts its benchmark rate, Treasury yields often move in anticipation. But the relationship isn’t direct; it can zig then zag. Treasury yields can fall even when the Fed holds rates steady. However, they can rise after rate cuts, based on inflation expectations and economic data.
“The 30-year fixed-rate mortgage really isn’t tied to the Fed funds rate, at least not directly,” said Cristian deRitis, deputy chief economist with Moody’s Analytics. DeRitis pointed out that the last time the Fed cut rates at its December meeting by 0.25 percentage points, mortgage rates actually went up on the heels of a rising 10-year Treasury.
Here are some of the key factors that impact the 10-year Treasury—and long-term mortgage rates:
- Monetary policy: While the Fed’s rate decisions have some indirect impact on mortgage rates, investors really watch future monetary policy and expectations of how the Fed will respond to certain events. Investors set the rate they’ll accept on the 10-year Treasury based on how short-term rates will perform during the bond period. The Fed has signaled there will be far fewer rate cuts in 2025 amid inflationary concerns and trade risks.
- Inflation rates and forecasts: Higher inflation (or expectations of it) pushes mortgage rates up because lenders need to charge more to ensure their returns exceed rising prices and maintain purchasing power.
- Housing market conditions and buyer demand: Strong housing demand and limited inventory can drive rates higher as lenders adjust pricing to manage volume. Meanwhile, slower markets may lead to more competitive rates to attract borrowers.
- Lender capacity and competition: When lenders have excess capacity, they may lower rates to attract business, but when they’re at maximum capacity, they often raise rates to slow applications and maintain service levels.
- Secondary mortgage market dynamics: Since most mortgages are sold to investors through mortgage-backed securities, investor demand and risk appetite in the secondary market directly influence the rates lenders can offer borrowers.
- Credit and default risk: Higher perceived risk of borrower defaults, either due to economic conditions or riskier borrower characteristics, prompts lenders to charge higher rates to offset potential losses.
- Overall U.S. economic growth: Strong economic growth typically leads to higher rates as borrowing demand increases and inflation risks rise. On the flip side, slow growth or recession fears tend to push rates lower.
- Global market conditions: International economic events and policies can drive foreign investment into or out of U.S. bonds and mortgage-backed securities, affecting domestic mortgage rates.
- Mortgage-backed securities (MBS) performance: Since lenders price their mortgages based on what they can sell them for in the secondary market, the yield investors demand for mortgage-backed securities directly impacts consumer mortgage rates.
Trump’s policies add uncertainty to mortgage rate mix
President Donald Trump recently said he’d “demand” an immediate drop in interest rates during a video speech in January to global leaders at the World Economic Forum in Davos, Switzerland.
His comments were an initial hit at Fed officials whom he often criticizes for raising rates during the COVID-19 recovery. His ire has been particularly sharp at Fed Chair Jerome Powell, who Trump appointed during his first term.
However, a president doesn’t have the authority to “demand” lower interest rates by edict. Trump also doesn’t have the legal ability to immediately replace Powell, and previously said he was not planning on trying to remove the Fed chair.
While some of Trump’s executive orders on pausing regulatory actions helped ease mortgage rates in the first week of his presidency, long-term mortgage rates might be headed for more volatility with geopolitical uncertainty and a looming global trade war.
On Saturday, Trump signed an executive order levying 25% tariffs against Canada and Mexico and 10% tariffs on China set to go into effect Tuesday—although it was announced on Monday that both sets of tariffs would be paused for at least one month. Canada and Mexico say they will retaliate with tariffs of their own, leading to an economic showdown—one where consumers will ultimately pay the price.
The cost of everything from gas, food, steel, lumber and other building materials will likely increase due to tariffs, pushing U.S. inflation up higher. In turn, that will drive higher interest rates (including mortgage rates) across the board for American consumers as companies pass tariff costs down to their customers, analysts say.
