Rate Expectations
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We are mere days away from a big Fed announcement. By all accounts, Jerome Powell, chairman of the Federal Reserve, is expected to cut interest rates next week. And people expect that because he's basically been saying this is going to happen for months. Yeah, I mean, albeit in these very Fed-speaky ways, you know, like this. It will likely be appropriate to begin dialing back policy restraint at some point this year.

Translation? Rate cuts are coming soon. Possibly. Yeah, here's another one. If the economy evolves broadly as we expect, most FOMC participants see it as likely to be appropriate to begin lowering the policy rate at some point this year.

Yeah, you know, lots of people have been watching that and hearing this stuff and interpreting it as interest rates are going to drop soon. You know, of course, fancy financial types are watching this, but also regular people. Yeah, because changes in interest rates can affect everything from the amount you earn in a savings account to the interest you pay on a credit card to the rate you get charged when you take out an auto loan.

But, but, Alexi, I would argue, I think both of us would argue, there is one group of people in particular who have been waiting for the Fed to make a move more than anyone else. That would be homeowners. If you had to describe your place in a couple of words, what would it be? Cozy is charitable. Uh-huh.

This is Brenda Miller from Los Angeles. She bought her house in 2010 when she and her husband had one child. The place has two bedrooms, one bathroom. It's 720 square feet, which is cozy, yeah. But with one child, no problem. It worked. But then they had another child and then another child. And now they are a family of five plus... We have a really large German Shepherd. Okay. Okay.

An elusive cat and two frogs. The frogs? Why do you have frogs, Brenda?

My teen is obsessed with frogs and did a whole PowerPoint presentation about why we should get frogs and did a science fair project on them. Yeah, so that's like nine carbon-based life forms squeezed into a two-bed, one-bath, and it is not going great. They fight over the bathroom. The frog aquarium takes up like two to three percent of the square footage. And you do not have to be a genius to know that, like, maybe it'd be nice if Brenda and the family had a little more room.

The problem is they have an amazing mortgage. 2.625, which is super low. I know. Oh, my God.

Yeah, Brenda locked in 2.625% back in 2021, when you could get some of the lowest mortgage rates in the history of the country. Now, a mortgage is, of course, a house loan. So every month, Brenda owes the bank some payment plus 2.625% of like whatever's left on their house. However, if they were to take out a mortgage right now, rates are an average of 6.35%.

So, you know, more than double what she's currently paying in interest every month. And what all this means is that it is really hard for Brenda and her family to justify moving. Like they would have to swap their cheap mortgage for an expensive mortgage. Plus, they'd be buying a bigger, more expensive place at that higher mortgage rate. Yeah. And so that would be thousands, literally thousands of dollars more at the current interest rates.

And that is just not feasible. That is thousands more dollars per month. And so they are stuck with what many people call golden handcuffs. Golden because this is a good problem. They own a house and they have a historically good mortgage rate. And handcuffs because they are stuck. And Brenda, she's fully aware that she is locked into a pair of those golden handcuffs. Oh, yeah. Oh, yeah. And how do you feel about it?

I'm really thankful that we have a house and I'm thankful that we have a place to live.

But at the same time, I mean, I have dreams where I'm like walking through a house and it's like, oh, I didn't know this room was here and like finding hidden space. And then I wake up and it's like, no, there's no hidden space. So we just have to get creative. And Brenda is one of tens of thousands, hundreds of thousands of Americans also wearing the golden handcuffs. It is messing things up for them, obviously, but it's also messing things up for the housing market for everybody.

Hello and welcome to Planet Money. I'm Kenny Malone. And I'm Alexi Horowitz-Ghazi. And after years of the Federal Reserve's interest rates going up and up and up again, it seems like we are finally on the cusp of rates going down, which should trickle through the entire economy and make it cheaper to borrow money. That is what should happen.

And so today on the show, simply put, what happens when the rates cut through specifically the lens of housing? How will it affect mortgage rates and the housing market? Will it unlock the pesky golden handcuffs mess? And will it help the rest of us, including people like you and me, Alexi, who do not own a home at all yet? Fingers crossed, Kenny. ♪

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Now, golden handcuffs is clearly the most fun way to talk about people who have such amazing mortgages that they don't want to move. But there is a more technical phrase for this situation. It is known as being locked in. Yeah, that's what people who study this stuff call it, including Professor Julia Fonseca, who is herself amongst the locked in.

So I have a 2.1% rate on a 15-year fix, so that is extremely low. Mm-hmm. If you hear a bit of jealousy in my voice, you are correct. 2.1% is bananas. Although unlike the golden-handcuffed Brenda Miller and her family, Julia says she's actually pretty happy in her house and not actively looking to move. I mostly just have housing FOMO.

And so, you know, I always wonder, is there a better house out there? We would describe you as locked in-ish. Well, so the way that... Happily locked in? Happily locked in, I would say. Julia is a professor of finance at the University of Illinois, and she says there are so many people locked in, or I guess happily locked in, in part because of what's happened with mortgage rates over the last 40 years.

Since the 1980s, rates have been generally dropping and dropping and dropping. So yeah, some people bought a house at the exact right moment, when rates hit the lowest in history, an average of 2.65%. That was back in January of 2021. Plus, other people were able to refinance during this time and also got incredibly good, historically good mortgages. And so to put some numbers to this, as of March...

Nearly 60% of borrowers have locked in a rate at or below 4%. So they get to keep this rate for decades so long as they don't move. So six of every 10 borrowers are very locked into their mortgages right now. And if they get a job offer somewhere else or if they want to move nearer to family, well, Julia's research shows that people are often deciding like, nope, I have to stay put.

But the thing that I think we can't lose sight of is that these decisions then go on to affect other people. Right. And to understand that, Julia says, you have to first understand that in normal times, there's this critical natural cycle to housing. Yeah, people, you know, they rent. Then maybe they buy their first home. Then if their family expands, they move up again to a bigger home. You can think of the housing market as this latter. Right.

So yeah, people start out climbing up this ladder. And then at some point, when they get older, maybe the kids move out, people sell their bigger home and start moving back down that ladder.

That is the natural cycle. People move out and new people have places to move into. The problem is that cycle is broken right now. Super broken. Like, Jaliga's research shows that even 80 to 85-year-old homeowners, especially in expensive areas, are still somewhat locked into their mortgages. So...

These aging owners at the top of the ladder, they often have no reason to start climbing back down the ladder. No reason to downsize because selling their big home means losing their great mortgages. And this, Julia says, is a big part of what's locking up the whole housing cycle. So owners of large homes are staying put. Now that's going to make it harder for owners of smaller homes to upgrade because

And that in turn is going to make it harder for renters to then buy their first home because those are typically those smaller homes. Do we know at what number this unlocks?

Right. So the point where people would get unlocked, that is where the difference between your rate and the current rate is a little below 2%. That is when you're no longer locked in. So homeowners theoretically need rates to drop about 2% below their current rate. This is because it costs money to trade in a mortgage to either refinance or get a new mortgage for a new house.

But, like, think about what that means. So, you know, Julia mentioned earlier that the majority of borrowers are golden handcuffed with mortgages at 4% or lower. That is really low. And yet they would need even lower rates. They would need new historically low rates before they are all unlocked from their golden handcuffs. But Julia says those are just theoretical unlocking points. In reality, lots of homeowners can't wait for a perfect number.

So to get a sense of what's happening on the ground, we called up. Hi, I'm Sarah Haik, a residential real estate agent in Washington, D.C. A realtor. Sarah is a realtor, and she's sold dozens and dozens and dozens of houses during this notably strange housing market. And we asked Sarah when she thinks things will start to unfreeze.

You know, there's this prediction among real estate agents that once rates hit 5.99, we're going to see a flood of new listings hit the market. 5.99. For reference, mortgage rates are between 6 and 7 percent right now.

So then would dropping below six fix everything? Well, that is complicated because of just how broken housing has been. Yeah. So, you know, just to step back for a second to talk about some basic housing supply and demand stuff. You know, over the last few years, mortgage rates have gone up, which means it costs more to borrow money and buy a house. So people should want to buy houses less. And then in response to this drop in demand, home prices should theoretically drop.

However, that is not really what's happened. You know, some housing markets may have cooled off a little bit, but generally, home prices have been higher than when rates started to go up. And that's in part because supply has also kind of dried up. Like, all these golden handcuffs mean lots of homeowners do not want to sell their house.

We simply don't have enough homes for everyone. And that's what has kept home prices increasing regardless of what the interest rates have been. Now, maybe you've been shouting at your podcast app this whole time, what about building new houses? Well, that is not happening either. Like lots of reasons for that, including high interest rates.

Right. It costs more to borrow. Developers might not be building as much new housing. And in fact, new builds are down about 20% from a few years ago.

Like, look, interest rates and mortgage rates, they are not the only thing that affects the housing supply and demand. But they certainly matter a lot in a moment like this. And that's why lots of people seem to be watching the Fed, wondering when those rate cut announcements are coming. After the break, we try to ask the Fed if they can fix all of this, assuming the Fed wasn't on a working vacation in a scenic Wyoming town.

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The town of Jackson Hole, Wyoming is famous for, I quote here, upscale ski resorts, rustic campsites, and dude ranches. And I had to Google that because as a Planet Money host, I know Jackson Hole for a big old economic symposium that happens there every August. Anyone who's anyone in the world of central banking goes, and the most anticipated part is a speech by the chairperson of the Federal Reserve.

Now, we are mentioning all of this because this whole episode was reported the week of that Jackson Hole symposium, which meant that anyone who works at the Fed was very hard to get on the phone. So we called someone who used to work at the Fed. Don Cohn. Hey, Don, it's Kenny Malone from Planet Money. Don was at the Fed for about 40 years. The last four of those, I was the vice chairman to Ben Bernanke.

through the financial crisis. Oh yeah, Don's a real one. And even though he hasn't worked at the Fed for more than a decade, he told us he was all packed up and headed to... where else? Where are you headed? To Jackson Hole. You're going! Yeah, I am going. I've been going for many years, but yes. We did want to grab Don quickly because, well, everyone thinks rate cuts seem to be coming, and Don has been in the room when rates have changed in the past. And we wanted to know...

Like everything. How exactly does a cut ripple through the economy? What will it mean for mortgages? And what is happening? Like what is literally happening the exact moment the rate gets cut? Is there a person who presses a button and makes that change? Not really.

Now, after much digging and asking around, I can tell you that the announcement is made, a computer team programs the rate change into a computer, and then the new rate goes into effect the following day. So, you know, someone seems to be pressing some button at some point.

Yes, it does. But let's talk about what rate or rates would actually be changing here. The rate that's worth focusing on is an interest rate that you and I will never have access to, Kenny. It is called the IORB, or the Interest on Reserve Balance. I've been taking to calling it the YORB.

Sure, but the YORB, we should say, is just for banks because one special thing that banks can do is hold money at the Federal Reserve and the Fed pays interest on that money. So, you know, when a rate cut is announced...

The YORB is one of the rates that the Fed is actually setting. And right now it's set at 5.4%. And people are expecting Jerome Powell to announce a cut to this rate, probably a quarter or a half a percentage point. Now, imagine you are a bank and you have this kind of savings account at the Fed. Suddenly, that savings account pays less interest. Yeah.

And well, you know, OK, so now the bank is less excited about storing its money at the Fed. So maybe the bank is more likely to lend that extra money out, maybe even at lower rates, lending it to other banks. So you can imagine more money starts flowing, and that just kind of ripples through the whole economy. Right.

But in reality, the ripple is less like a bunch of dominoes falling one by one by one and more like all the dominoes falling at once. The announcement is made and it happens in markets right away. Was that a finger snap I heard there?

Well, it could have been. It was a figurative finger snap. Lickety-split, all of these members in the markets adjust to the new norm, an ever so slightly lower interest rate. So, you know, literally changing a rate, the YORB rate, I guess, in this case, that is one of the Fed's most important tools. But it goes hand in hand with another tool, managing the market's expectations about the rate cut. So.

So this is really, I can't emphasize enough, this is about their expectations about the future

If the Fed does what everyone expects it to do, sort of nothing will happen in markets, or very little will happen in markets. In fact, markets have already been adjusting to the future Fed announcement because, for months, the Fed has been saying things that sound an awful lot like, you know, we're looking at a rate cut. A rate cut? Yeah, we're looking at it. Okay, a rate cut increasingly makes sense.

We let Don jump off the phone and get back to prepping for his Jackson Hole trip. Thank you so much for doing this in a pinch. I really appreciate it. All right. Bye-bye. And on we went to try and understand the expectations bit a little bit more. And we called up Gina Smilick. I'm the Fed and Economy reporter at The New York Times, and I'm the author of Limitless, which is a book about the Fed in the 21st century. So what time did you say it was there? It's 5 a.m. Not too crazy.

I mean, maybe a little, but very generous because Gina was in fact already in Jackson Hole, Wyoming. And we learned how small the world of the Fed is when we told her we did just talk to former Fed Vice Chair Don Cohn. He was like, Pat?

packing his bags on the way out the door. Oh, I didn't realize he was coming. Oh, that's great. He's coming. Oh, cool. I'll email him. Now, it is actually quite useful that everyone is circling around Jackson Hole because it is a perfect example of this second very useful Fed tool. The way the Fed can use expectations to its rate-changing advantage.

Yeah. So as we mentioned, the economic symposium at Jackson Hole, it all centers around a big speech from the Fed chair, Jerome Powell. But to be clear, this is not the speech where he announces a rate cut or not a rate cut. It is just a speech. But of course, every word of every Jerome Powell speech gets scrutinized and interpreted like some ancient Babylonian tablet.

You know, I think there's a whole cottage industry of people who spend their day, which I help fuel and the media helps to fuel, of people who spend their days just trying to figure out what the Fed's going to do next.

This is what Don meant by expectations. Actually, changing rates matters, of course. But the Fed has come to realize that a powerful tool in its arsenal is just talking, laying down clues and hints and details about the things the Fed is watching, and then letting that cottage industry scramble and make their market moves based on that.

Sometimes this tool is called open mouth operations, which is a play on open market operations, which is the old way the Fed used to primarily move interest rates, which is a deeply nerdy and solid Fed joke. And it is OK if you don't get it.

Yes, it will not be on the test. But Gina says the Fed has realized that just talking about changing interest rates can affect markets. This current juncture is a great example, actually. They're clearly sort of like pivoting their stance and trying to get to a point where interest rates are a little bit lower. And they've managed to lower interest rates quite a bit without actually lowering interest rates at all, just through open mouth operations, you know, just by talking.

It's true. The Fed has not cut rates. And yet the market has been slowly building in a rate cut, especially if you look at things that have a longer lifespan. So these are investments that are really more about the general direction of things. You know, the 10-year treasuries, those have started to move as if, oh, looks like rates will be coming down over the next few years. And also mortgages. Those rates have also been slowly coming down, again, without any actual cuts from the Fed.

Now, we should mention markets are also watching things like job numbers and inflation numbers and reacting to that stuff, which the Fed is also watching and reacting to. And the markets know that the Fed is also watching and reacting to that. And so it is just this like really tied up, tangled expectations knot.

But look, the point here is if you are looking to buy your first home or if you're blocked into a really good mortgage, it is probably not going to help to watch the Fed make an announcement.

Because, as Gina puts it... It's not that they're directly going out and saying, hey, Mr. Mortgage Man, like, you bring down your rate. It's that when they set that benchmark rate, it really trickles out. Yeah, it trickles out. And the people who sell mortgages and trade mortgages, they shift their expectations and what they're willing to buy and sell mortgages for. When the rate cut does come, the only thing that would move markets is a big old surprise if Jerome Powell did something totally unexpected.

And at this point, not cutting rates would be that.

Gina says the market is already betting on one of two rate cuts. You know, people are betting it could be either size 25 or 50. 25 or 50 basis points. So that's one quarter of a percentage point or one half of a percentage point. And so I think that's actually one thing people are really closely watching Chair Powell for. What if you threw him 37.5 basis points, like smack dab in the middle? That is not how the Fed works. The Fed moves in 25 basis point increments. That's too bad. That's too bad.

That would surprise everyone. So should you expect mortgage rates to suddenly come down if the Fed cuts its interest rates in mid-September? The answer is not really. They've been slowly coming down already because everyone has been expecting the Fed to make this cut. And, you know, quick postscript here in case you missed it. Since we started reporting this episode, the big old Jackson Hole speech, it's happened.

Thank you, Karen, and thanks to our host from the Kansas City Fed. Jerome Powell came out and said, frankly, possibly the clearest thing he has said in months. The time has come for policy to adjust. The direction of travel is clear and the timing and pace of... Honestly, no translation needed this time.

This episode was produced by Sean Saldana. It was edited by Jess Jang and fact-checked by Sierra Juarez. Engineering by Sina Lafredo. Alex Goldmark is Planet Money's executive producer. A very, very special thanks this week to Shep Bashar and Jonathan Wachter. I'm Kenny Malone. And I'm Alexi Horowitz-Ghazi. This is NPR. Thanks for listening. ♪

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