Aug 25, 2025 4:39:11 PM
Your members are probably wondering why mortgage rates aren't dropping with the Federal Reserve on the verge of lowering its benchmark rate. To answer this question, your staff needs to understand that short-term interest rates are driven by different factors than long-term rates.
The Difference Between Short-Term and Long-Term Rates
The Federal Reserve directly controls short-term rates, like the fed funds rate, through its monetary policy decisions. These rates influence things like credit card rates and auto loan rates. But long-term rates, such as the 10-year Treasury yield, which heavily influence 15 and 30-year fixed-rate mortgages, are driven by the broader bond market.
The bond market is a complex web of investors, and long-term bonds yields are a reflection of their collective expectations for the future. So, even if the Fed cuts its short-term rate, the long-term rates might not move in lockstep. This is because long-term rates are a function of much larger economic forces.
The Formula for Long-Term Rates
The 10-year yield is equal to the nominal potential GDP growth. Economists often use the following formula to compute that nominal rate:
Expected Inflation + Labor Force Growth + Labor Productivity Growth
Expected Inflation: If investors believe inflation will remain "sticky" and higher than in previous decade, they'll demand a higher return on their long-term bonds to compensate for the loss of purchasing power. Most economists currently anticipate inflation to be higher over the next 10-15 years than it was in the past.
Labor Force Growth: This reflects the rate at which the workforce is expanding. A slower rate of labor force growth, often due to declining birth rates and more restrictive immigration policies, can put downward pressure on long-term rates.
Labor Productivity Growth: This is a measure of how efficiently the workforce is producing goods and services. While new technologies like artificial intelligence could potentially boost productivity, this has been a difficult factor to forecast. Historically, the last major surge was in the late 1990s and early 2000s, driven by the broad adoption of the internet.
So, while a slow-down in labor force growth might help, the current expectation of higher inflation is a significant factor keeping long-term rates elevated.
Other Factors Influencing Long-Term Rates
Beyond the formula, there are other important factors that can push long-term rates higher or lower. Historically, long-term rates have tended to be lower than nominal GDP growth during periods of loose monetary policy (like the 1970s or post-Great Recession) and higher during periods of tight monetary policy (like the 1980s or the last couple of years).
Another significant factor, and one that is very relevant today, is fiscal instability. When the government's debt-to-GDP ratio increases, it can put upward pressure on long-term rates. The federal debt has climbed significantly since the 2008 financial crisis, and forecasts suggest this trend will continue. This ongoing concern about fiscal stability acts as an amplifier, keeping long-term rates propped up.
Setting Realistic Expectations for Members
The key takeaway for you and your team is that long-term rates are likely to remain elevated as long as fiscal and political risks remain. The mortgage rates we saw five or six years ago were a historical anomaly, driven by an era of extremely loose monetary policy and quantitative easing. They were, in effect, a "once-in-a-lifetime" opportunity.
While rates could certainly fall if a recession prompted the Fed to re-engage in quantitative easing, the most likely scenario is that long-term rates, and thus mortgage rates, will remain in a range similar to where they are now. They might be a little elevated or range-bound, but it's unlikely we'll see a return to the historic lows of the last decade.
By educating your team on the difference between short-term and long-term rates, and the broader economic forces at play, you can confidently and transparently manage member expectations. This will help them understand that while rate cuts are coming, they won't automatically translate to the ultra-low mortgage rates of the past.