The 30-year mortgage rate is declining toward 6% after the Federal Reserve cut interest rates on September 18. That’s down from similar mortgage rates approaching 8% in November 2023, which may have been the peak level for this cycle.

The Fed doesn’t control mortgage costs directly. But the market’s expectation that interest rates are moving lower, together with cooling inflation, have been significant factors in helping bring down mortgage rates over the past 12 months. From here, it’s possible rates will move lower. However, that will depend on what the Fed does compared to market expectations, as well as other economic factors such as inflation trends.

Market Expectations

Current 30-year mortgage rates reflect fixed income markets’ expectations about future Fed decisions. So, the recent decline in mortgage rates reflects the market’s prediction that short-term interest rates are likely to decline. If that prediction proves inaccurate, then mortgage rates could move back up.

However, if the Fed does cut rates more aggressively than expected, maybe mortgage rates could move lower. Broadly speaking, the market is projecting that short-term interest rates will end 2024 at close to 4% and then be in the region of 3% in December 2025. Should the Fed be more or less aggressive in cutting interest rates than those implicit estimates, then the mortgage rate may move down, or up, respectively.

For example, if the Fed decided that it wasn’t worried about a softer job market and inflation surged, then mortgage rates could move higher again. Economists don’t view this scenario as a particularly probable one, but it is possible. Equally, if there were a deep U.S. recession, the Fed might cut rates dramatically, potentially helping pull mortgage rates down from current levels.

A Return To Low Rates?

Mortgage rates are now much higher than 2020 to 2021 when the 30-year rate temporarily fell below 3%. Fed Chair Jerome Powell was asked if he thought the economy would return to that level at the recent Fed meeting on September 18.

“Intuitively most, many, many people anyway, would say we’re probably not going back to that era where there were trillions of dollars of sovereign bonds trading at negative rates, long-term bonds trading at negative rates.” Powell said. “And it looked like the neutral rate was, might even be negative, so and it was, people were issuing debt at negative rates. It seems that’s so far away now, my own sense is that we’re not going back to that. But honestly, we’re going to find out. But it feels, it feels to me, and that the neutral rate is probably significantly higher than it was back then. How high is it? I don’t, I just don’t think we know. It’s, again, we only know it by its works.”

What To Expect

From here, one key question for the mortgage market will be: What is the long-term rate for neutral short-term rates. The current expectation is that the short-term rate is around 3% on a neutral basis, according to both markets and Fed policymakers. Of course, mortgage rates build in a premium to that risk-free, short-term rate, as lending to an individual homeowner is riskier and more complex than lending to the U.S. government. Then a second question is: How fast will the economy get there? Current expectations are that we may see short-term interest rates of about 3% by late 2025.

However, many economic events could change that trajectory quite dramatically. We may now be past peak interest rates for this cycle as inflation has cooled, but where mortgage rates settle in the future remains an open question. Mortgage rates currently reflect some optimism that interest rates are coming down quite sharply over the next 12 months.