Your economics lesson for the day

Word on the street is that the Fed is expected to cut interest rates to below 4% on Oct. 29. What’s more, another cut could come in December. The cuts may only be a quarter-point, but that would mean the three cuts since the summer amounting to a collective three-quarters of a point. Now, before you reach for that Modelo and think mortgage rates are immediately going to drop that same three-quarters of a point, you may want to put your bottle opener back in the drawer. For those who may not have majored in Economics, unlike me (you can see how much I’ve done with that degree, but that’s a story for another day), let’s have a little lesson. School’s in.

Let’s start with some economics basics to provide a backdrop. The Fed’s job is to balance inflation—which is currently a little over its 2% annual goal—and the jobs market, which appears to be softening. Higher inflation would call for higher rates, but risks to the jobs market may imply a need for lower rates. The Fed cannot do both. It will watch inflation trends closely, because if inflation does accelerate, then it may find it harder to cut rates unless the jobs market shows real distress.

Still with me?

So what does this all mean for you in particular and this industry in general? First of all, if the Fed lowers its key rate as expected, interest costs on many types of short-term debt would fall. That includes credit cards, car loans and anything tied to bank prime rates, which are often set at a certain percentage above the fed funds rate.

When the Fed cuts rates, the prime rate (interest rate banks charge their most favored customers) falls; savings account rates fall, and loan rates fall. Soon after, credit card rates fall.

The key here for the flooring industry is loan rates. That includes personal loans, home equity loans and home equity lines of credit (HELOCs). So many flooring purchases are financed through home equity loans and HELOCs. When those rates are high, people are more reluctant to spend. So that rate is a number to watch, just as much as the mortgage rates.

The second part of our lesson involves mortgage rates, which are longer-term debt, most often 30 years. The fixed rate you pay is evergreen with a margin built in to last through many interest rate cycles. So it’s priced to a longer-term benchmark, like the 10-year Treasury. How it works: To determine current mortgage rates, lenders add a spread to the Treasury yield. The spread is the difference between the rate you pay and the rate on the Treasury. That spread helps lenders cover costs associated with making loans to the public and the risk of providing these loans. Does that make sense to you?

The bond market reacts to longer term events, like inflation, employment and macroeconomic trends. Sometimes mortgage rates fall after a Fed rate cut and sometimes they don’t. Many times they will decline in expectation of a rate cut in the weeks leading up to a Fed meeting, then bounce back up.

In illustration, the 30-year fixed rate average dropped from 6.89% in May to 6.25% on Sept. 18 before moving up to 6.30% on Sept. 25. So what actually lowers mortgage rates? It’s not the Fed—it’s the economy, stupid. Soft inflation and employment. Yes, when your neighbor loses his job, that in theory could be good for you if you’re looking for a mortgage. Bad for you if he is constantly knocking on your door looking to hang and drink your alcohol because he’s bored.

Here’s what I think: It’s as much psychological as anything else. As much as we got used to those 3% rates that everyone and their mother jumped on, we also got used to those 8% rates that we avoided like the plague. There’s pent-up demand to buy a home. If we can mortgage rates to a fraction under 6%, I believe we will now be comparing that to the 8% and not the 3%. And 5.875% will appear like a good deal, and the floodgates will open. We’re expecting that to happen in 2026. Fannie Mae says late 2026; I think maybe sooner.

Be ready. When people buy homes they also buy flooring. But you already know that.

Now, to quote Alice Cooper, “School’s out.”

When inflation is high, the Fed raises the rate to discourage borrowing and cool down the economy, allowing supply and demand to rebalance. When the job market weakens, the Fed cuts interest rates to encourage business and give a boost to hiring.

The post Your economics lesson for the day appeared first on Floor Covering News.

Your economics lesson for the day Posted First on https://fcnews.net