Why Are Interest Rates Going Down After the Fed Raises Rates?

August 18, 2022

By Jeff Matlock, Director

There is a lot of confusion and misconceptions when it comes to the Federal Reserve raising rates. With the recent increase of .75 percentage points, the federal funds rate ranges from 2.25 to 2.50 percent. The Fed is making these increases to battle inflation and the rate adjustments affect banks’ liquidity and the rate they pay when borrowing from the Federal Reserve.

It’s important to note that mortgage rates are entirely independent of the federal funds rate. The majority of commercial mortgage loans are priced off of 5, 7, or 10-year US treasury rates. In recent months, the 10-year Treasury rate has rapidly increased at the same time as the fed fund rate increased, leading to the misconception that the two are linked.

The bond market is signaling that it believes a recession is becoming more and more likely. Short-term treasuries and long-term treasuries (10-year Treasury) have inverted. The Fed is increasing short-term borrowing costs while the market is signaling that it believes rates 5 and 10 years from now will be lower than they are today. Long-term bonds and interest rates are looking forward past the current inflation, and believe a recession is coming. Therefore, as the Fed Funds Rate continues to increase, the mortgage rates will likely go down due to recession fears. Many believe the Fed will reduce rates in a recession to stimulate the economy. This explains why the 10-year Treasury is down 0.50% in the past 2 weeks, even with the Fed raising rates 0.75% on July 27.

The yield curve has been a hot topic and has inverted prior to every recession since 1955. An inverted yield curve is defined by the two-year treasury rate being above the 10-year treasury rate for two consecutive quarters. The yield curve inverted in March and remained inverted in June, signaling a recession is coming.

 

According to Bloomberg, the 3.5% 10-year Treasury yield may be the peak for 2022, and it’s possible that if the trends we are seeing continue, the 10-year Treasury yield could fall as low as 2.5% in the second half of the year. This is good news for investors looking to finance upcoming commercial real estate investments.

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