Fed hikes rates. What does it mean for your mortgage?

Fed raises rates, citing good economic outlook

The Federal Reserve on Wednesday hiked its benchmark interest rate by a quarter percentage point, citing a gradual strengthening in the economy.

In her final press conference, Federal Reserve Chairwoman Janet Yellen said the Fed’s decision will help buoy the strong job market and gradually bring inflation back up to the Fed’s 2 percent target.

So far this year, inflation has been running well below 2 percent.

Sustained low inflation prompted two FOMC members to vote against raising rates, preferring to keep current rates in place. As new members join the Federal Open Market Committee in January, votes are expected to be more bullish in favor of rate hikes.

Federal Reserve calls for more hikes in 2018

The Fed still projects to hike rates three times in 2018.

The neutral level of the federal funds rate is expected to rise gradually, making it likely for gradual rate hikes over the next few years, Yellen said.

“Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades,” Yellen said.

Some economists are surprised the Fed isn’t looking to hike rates with more frequency next year.

“With this optimistic outlook, driven in part by the spur in demand expected from the tax cuts, it is surprising that the Fed still expects just three rate hikes next year,” said Michael Fratantoni, chief economist with the Mortgage Bankers Association. “We think they are likely to revise up this guidance early next year to show four hikes in 2018.”

What the rate hike means for mortgage rates

Over time, borrowers might see higher mortgage rates as the Fed continues to increase short-term rates and shrink its balance sheet, Fratantoni said.

“We expect that short rates will continue to increase faster than long rates, leading to a flatter yield curve,” he said.

A flattened yield curve means that short-term bonds pay almost as much interest as long-term ones. Typically, for instance, a 10-year bond will pay an investor a much higher interest rate than a 2-year.

As recently as January 2014, the difference in rate, or “spread,” between these two bonds was 2.6%. In December, it hit a low of 0.53%.

“We do expect that mortgage rates may also become somewhat more volatile in the year ahead, particularly as the Fed allows its [mortgage-backed securities] portfolio to run off at a faster rate through the course of the year.”

GDP growth to ‘moderate’ to 2 percent by 2020

The Fed forecasted a slight decline in real GDP growth over the next three years, which might be an issue to keep tabs on.

The median real GDP growth is expected to run 2.5 percent this year and in 2018. However, the Fed estimates it will “moderate” to 2 percent by 2020, slightly above its longer-run rate.

Compared with the Fed’s September forecast, “real GDP growth is a little stronger, the unemployment rate is a bit lower, and inflation is essentially unchanged,” according to an FOMC statement.

Also, expected changes in U.S. tax policy help support the stronger outlook, but “much uncertainty” surrounds the exact execution of tax reform, the FOMC said.