By Holden Lewis | NerdWallet
After climbing solidly higher in October, mortgage rates are likely to continue rising in November, but not as steeply.
The average rate on the 30-year fixed-rate mortgage was 3.04% in October, a significant increase from September’s average of 2.91%. It was the biggest one-month increase since March, when vaccine rollouts were nurturing optimism. But in October, a not-so-optimistic force nudged rates higher: inflation.
Prices rose 5.4% year over year in September, according to the most recent Consumer Price Index report. It was the highest CPI figure since July 2008. The Federal Reserve’s favored inflation report, known as the Personal Consumption Expenditures: Chain-type Price Index, was up 4.3% year over year in August, the highest reading since January 1991.
Why inflation pushes rates higher
Your mortgage lender strives to charge an interest rate that’s higher than the expected long-term inflation rate. Otherwise, inflation will eat into the lender’s profits. Think of it this way: You lend a friend $10 for lunch and your friend pledges to repay it in a year at 3% interest. A year later, your friend hands you the promised $10.30. But if that same lunch now costs $10.54, you came out on the losing side of that loan. You got a 3% return, but it was exceeded by 5.4% inflation.
Whether you measure it using the CPI or the PCEPI, inflation has risen steeply this year. That, by itself, is enough to lift mortgage rates. Meanwhile, the Federal Reserve’s presence in financial markets contributed to October’s mortgage rate increases.
Setting a match to the taper
When the COVID-19 pandemic provoked a recession early in 2020, the Fed responded aggressively. It slashed its benchmark federal funds rate to near zero. It also has been buying billions of dollars’ worth of government and mortgage debt every month, which effectively set a ceiling on interest rates for mortgages and other types of loans.
The Fed is expected to start scaling back, or “tapering,” the purchases of government and mortgage debt. Fed officials have signaled that the process may begin in November and conclude by the middle of 2022. Because the debt purchases are intended to help keep interest rates low, reducing those purchases might allow interest rates to rise. It’s as if mortgage rates were a kite and the Fed was letting out a couple more feet of string.
The mortgage market tries to anticipate future Fed actions, rather than reacting to the Fed’s moves after the fact. So October’s rise in mortgage rates is partially due to investors’ expectations that the Fed will begin tapering in November. Once the Fed makes it official, the effect on mortgage rates may be minimal because the market will have expected it.
Inflation is likely to remain, though, pushing mortgage rates slightly higher in November.
What happened in October
At the beginning of October, I predicted that mortgage rates would rise because investors would become increasingly convinced that the Fed would start tapering, causing them to demand higher interest rates. This was correct.
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