The Fed Futures market is currently predicting Fed Funds rates will have an 84% chance of dropping by 25 basis points in the Fed’s meeting next month, with a 100% chance of two cuts happening by December. Mortgage rates will not automatically drop on a day when the Fed announces a cut, unlike the way the Prime Rate index will automatically move 1:1 for any change in the Fed Funds rate.
However, mortgage rates will generally trend lower in anticipation of Fed rate cuts. Usually, the only time that mortgage rates have an immediate reaction to a Fed rate cut decision is if the decision is a surprise to what the markets had predicted. Otherwise, if the markets are predicting a near 100% chance of a rate cut, when it happens, there is usually zero impact to mortgage rates, because this news was already built into the price of an MBS before the Fed’s decision was announced.
Whenever MBS prices change, it means some surprise news occurred, and investors are adjusting their value of an MBS based upon the new surprise information.
As a reminder, the Federal Reserves Federal Open Markets Committee (FOMC) meets eight times per year and the FOMC’s 12 voting members can vote to change the Fed Funds rate which is the interest rate for 1-day loans made between banks who are members of the Federal Reserve system. A simple majority of the 12 voting members is required to make any changes to the Fed Funds rate. The FOMC consists of seven appointed Fed Governors and five presidents of Federal Reserve banks who serve on a rotating basis.
The Fed Futures Market. Investors are able to buy or sell futures contracts whose value is based upon future levels of the Fed Funds rate. The value of a contract at a future date is 1 minus the current Fed Funds rate. So, if the Fed cuts rates from 4.25% today to 4.00% in September, the September Fed Futures contract would be worth 1 – 4.00% = 96.00 in September. Every day the market value of these futures contracts will change based upon the market’s changing expectations for when the Fed will do their rate cuts. The current market price for these contracts, minus 1.0 equals the implied Fed Funds rate for different future dates. Below are the current implied future rates of Fed Funds based upon this morning’s Fed Futures market prices.
