Where Do Money Market Yields and Mortgage Rates Go from Here?

It finally happened. The Federal Reserve (Fed) cut interest rates by half of a percent (50 basis points) a few weeks ago. While this is good news for the short-run economy and for the stock and bond markets, investors should brace for significantly lower yields on their money market accounts. And, while you might be tempted to think mortgage rates will follow suit, they won’t budge all that much.

First off, trillions of dollars have been plowed into money market since 2022 as investors have been content to receive 5% or more in low-risk instruments. Now that the fed has lowered their benchmark rate down to a range of 4.5 to 4.75%, money market, cash, and CD yields will immediately decline.

Cash is about to lose its luster even further as most Fed officials expect at least another 200 basis point decline through the end of 2025. This would drop rates at the Fed discount window all the way down to 2.5%.

In other words, money market funds will likely be yielding half of what they are today. Your $100k money market fund at the bank that paid you $5000 virtually risk free per year is on the cusp of falling to $2500.

My expectation is that investors will seek alternatives from cash in 2025 and that bonds should gain in appeal, particularly high-quality bonds such as treasuries and municipals.

While we expect rate cuts across the board, don’t get overly giddy about mortgage rates. Though they are forecast to drop below 6%, much of the decline in rates is already baked into the cake. According to the Mortgage Bankers Association, they are forecasting an average rate of 5.8% for a 30-year fixed rate mortgage. The average 30-year fixed rate mortgage presently stands at approximately 6.09%.

If the Fed is expected to drop rates another 200 basis points, why are mortgage rates only expected to decline another 29 basis points?

As a reminder, when the Fed decreases the Federal Funds Rate, that tends to have a direct and immediate impact on other short-term debt instruments such as money market (which derives its yield from underlying short-term notes), CD’s, short-term bonds, credit card rates, etc.

Mortgage rates tend to track more closely with 10-year treasury rates, not the current Federal Funds Rate, which makes sense as they are both long in duration. The further you travel down the yield curve, the greater the impact of market forces. In other words, 10-year Treasury Bonds are very sensitive to expectations of future interest rates. Because the yield curve has already been inverted due to investor expectations of rate cuts, 10-year Treasuries aren’t expected to budge all that much. Mortgages should follow suit.

There are two important trends to note: 1) The 10-year Treasury yield peaked back in April of this year at 4.7% and 2) The average 30-year fixed mortgage rate peaked at 7.79% in October of 2023. Mortgage rates and treasury yields are already down significantly.

But if rates are high, why would a lender lower mortgage rates before rate cuts? That's because an investor can simply say, “I expect lower interest rates next year and I am willing to wait to buy a home.” This lowering of current demand puts downward pressure on mortgage rates.

It’s important to remember that mortgage rates tend to lead Fed rate cuts, as investors typically price in future cuts before they actually occur. In other words, mortgage rates are already baked into the cake. Money market yields, however, move with the Fed. Cash is about to be boring again.

Disclosures:

Any opinions are those of Drew Benson and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material, is being provided for information purposes only and does not constitute a recommendation. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rice. U.S. government bonds and Treasury notes are guaranteed by the U.S. Government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury notes are certificates reflecting intermediate-term (2-10 years0 obligations of the U.S. government. CDs are insured by the FDIC and offer a fixed rate of return, whereas the return and principal value of investment securities fluctuate with changes in market conditions. Raymond James Financial Services and your Raymond James Financial Advisors do not solicit or offer residential mortgage products and are unable to accept any residential mortgage loan applications or to offer or negotiate terms of any such loan. You will be referred to a qualified Raymond James Bank employee for your residential mortgage lending needs.