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The Federal Reserve pressed pause on its campaign of interest rate hikes Wednesday, keeping the federal funds rate at a range of 5.25% to 5.50%. This is the second pause since the Fed started increasing the fed funds rate back in March 2022.
The central bankers have made considerable progress toward achieving their goal of a 2% rate of inflation, and while they aren't there yet, the long-term effects of their rate hikes are still reverberating through the economy. If the bankers decide they've gone far enough, interest rates could stabilize in the coming months.
But the Fed hasn't indicated rate cuts are coming, so the overall cost of borrowing — including to buy a home — should stay relatively high. Stability is certainly preferable to a hike for home buyers, but it's little relief in the face of a challenging housing market.
The case for taking a break
In recent months, the central bankers have emphasized taking a data-driven approach, closely examining economic indicators to see how much effect their 18-month campaign of rate hikes has had. While a Federal Reserve announcement can bring about a next-day jolt in interest rates, the cumulative effects of each decision take much longer to play out. With two more meetings remaining this year, opinions are divided on whether another 25-basis-point increase is coming, or if the Fed might soon choose to hold rates steady.
"There's a lot of monetary policy tightening already in the pipeline, and that is starting to have effects on the labor market and on inflation," says Eric Swanson, an economics professor at the University of California, Irvine. "I think they want to wait and see how that plays out a little more and to get a little more data before they decide whether to raise rates again."
"Any time you see financial conditions shift as dramatically as they have over the past almost two years, it means a lot of adjustment for households and businesses, and I think we have yet to see the full effects," Danielle Hale, chief economist for Realtor.com, said via email.
On the other hand, "Have they raised rates high enough? Possibly, but I doubt it," says Rebel Cole, a professor of finance at Florida Atlantic University. “I think they're going to leave them high until core inflation drops down close to 2%,” which could mean another hike, or even two, he says.
Nor does he anticipate rate cuts on the horizon: "I think they're going to leave them high, probably through all of 2024."
Trying to strike a balance
The Federal Reserve doesn't want to stop hiking too early and have inflation creep back up. But it also doesn't want to risk tipping the economy into a recession by making its monetary policy too tight. That need to start fine-tuning could be behind the bankers' decision to pause and assess.
At the start of this inflationary cycle, the central bankers were hesitant to act, believing that inflation was a transitory after-effect of the pandemic. When it proved more stubborn than anticipated, the Fed began hiking the funds rate — its key tool for slowing the rate of inflation.
"They were behind the curve for a while, but they've caught up and they're now probably at about the right place and the economy is slowing down," Swanson says. "And if everything kind of continues, then the economy will probably continue to slow down but not have a recession."
Cole is less optimistic: “If you go back to 2000, early 2000s or mid-2008, before the financial crisis, they were talking, oh, we're going to have a soft landing. Boom. And every time, they always talk soft landing and then boom, there's a recession. Now, it may not be a terribly severe recession, but I don't see how we're going to avoid a recession," he says.
How a downturn could affect the housing market
Enough of an economic downturn could eventually lead to interest rate cuts. And hopeful home buyers struggling with high mortgage interest rates might be willing to take lower rates any way they can get them.
Hale noted that in a Realtor.com survey conducted in July, nearly 36% of home buyers said a recession would make them more likely to buy a home. "The share is higher for first-time home buyers, who are likely hoping that a break in mortgage rates and home prices during a recession would create an opportunity to buy a home," she wrote. Only 17.8% of home buyers said they would be significantly less likely to buy during a recession.
Rate cuts could perhaps prompt more homeowners to sell, increasing inventory, which might lower home prices. Citing “rate lock-in,” when homeowners cling to low-interest-rate loans even if they might have otherwise considered switching to a different house, Cole uses himself as an example: "My mortgage is at three and an eighth. Why would I want to get rid of that and go up with something at seven and an eighth or seven and a half?" Barring a life event that forces a change, at today's rates, "people are locked in," Cole says.
Home buyers may be tempted to mirror the Fed's wait-and-see attitude, but that could mean missing out on potential homes. Should the more dire economic predictions come to pass, those ready to buy now will have interest rates that are ripe for refinancing.