In this episode of the REconomy Podcast™, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi break down why Federal Reserve rate cuts don’t always translate into lower mortgage rates and how today’s complex economic environment may make the housing market less rate sensitive than many believe.
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“Housing doesn’t need a 5% mortgage rate to thaw. It just needs stability and a little relief. But most importantly, Fed rate cuts are not a cure-all. As we’ve said, this year’s activity will be driven by lifestyle choices—what we call the five D’s of home buying: diplomas, diapers, divorce, downsizing, and death.” — Mark Fleming, Chief Economist
Odeta Kushi - Hello and welcome to episode 126 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing, and affordability. I’m Odeta Kushi, deputy chief economist at First American, and here with me is Mark Fleming, chief economist at First American. Hey Mark, well—the Fed cut rates again.
Mark Fleming - Indeed, they did, Odeta. That was almost exactly—probably within a couple of days—of a year ago. So here we go. They’re trying to bring rates back down to earth. Get it? Earth? I know.
Odeta Kushi - Mm-hmm. Yeah, that’s Carly Simon, technically late ’80s. But we’ll count this as your obligatory ‘80s reference for the episode.
Mark Fleming - Actually late ’70s, but yes, give it to me this time. And who said I’m done with my references? We’re still early in this episode.
Odeta Kushi - Did I say late 80s? Yeah, I meant late 70s. Either way, let’s digress to today’s topic. We’re diving into a question that’s been on a lot of minds. If inflation hangs around 3% or climbs higher, and the Fed keeps cutting rates, what does that mean for mortgage rates, housing, and even commercial real estate? Because the assumption is simple. The Fed cuts rates, mortgage rates fall, housing booms. But, as we’ll explain, it’s not exactly that straightforward. The yield curve has something to say about that.
Mark Fleming - That’s right. For the last 30–40 years, that assumption held. The question now is: why isn’t it true anymore? A lot of it comes down to the yield curve—the curve that graphs treasury bond yields across maturities. And lately, the yield curve has been the star of the show. Spoiler alert: it’s steepening, and that’s a big deal for mortgage rates. The spread between the 30-year and the two-year treasury is close to the widest since 2022. Even though the Fed cut rates by a quarter point, long-term yields, like the 30-year, actually increased.
Odeta Kushi - Let’s also talk inflation. Headline CPI is about 2.9% year over year, core CPI at 3.1%, and core PCE—the Fed’s preferred measure—around 2.9%. So, we're not at that Fed target of 2%, but we're also not at 6% either, which is where we were a couple of years ago. We’re stuck in a “sticky 3%” inflation zone. Meanwhile, the labor market is cooling—August jobs gained just 22,000, far below expectations, with unemployment up to 4.3%. Layoffs are increasing, and job growth is narrowly concentrated in healthcare and hospitality. So this is a labor market really being driven by a few sectors. We also saw permanent layoffs increasing, so it's harder for job losers to find open positions. All things that the Fed is monitoring to make sure we're not headed towards a job loss recession.
Mark Fleming - First of all, phenomenal summary, Odeta. But wow—Debbie Downturn showing up early this episode!
Odeta Kushi - I knew you’d say that. But hey, they don’t call economics the “dismal science” for nothing.
Mark Fleming - True. For context, unemployment at 4.3% is still low and close to the Fed’s full employment goal. The Fed made its first rate cut of the year—25 basis points—and signaled two more before year-end. But they’re also running quantitative tightening, letting Treasuries and mortgage-backed securities roll off their balance sheet. That’s easing on the short end of the curve, while still tightening modestly on the long end.
Odeta Kushi - Exactly, which explains the steepening yield curve. Short rates move down, but long rates don’t always follow. The 10-year is still 4.1%, the 30-year closer to 4.7%, while the two-year is at 3.5%.
Mark Fleming - And the reason is the “term premium”—the extra compensation investors demand to hold longer-term bonds. Inflation worries keep that premium elevated, so even if the Fed lowers short rates, the long end stays sticky.
Odeta Kushi - That matters because mortgage rates are tied to the 10-year Treasury. Freddie Mac’s latest survey puts the 30-year fixed at 6.26%—down from 8% highs in 2023, but still far from the 3% days.
Mark Fleming - Here’s the myth-buster. Fed cuts don’t automatically translate into lower mortgage rates. As you mentioned, mortgage rates follow the 10-year Treasury yield plus mortgage-backed-securities spreads, not the Fed funds rate directly. Long-term rates are driven by two things: expectations of future short-term rates and the term premium. The Fed can influence expectations, but the term premium is a different animal.
Odeta Kushi - And that’s where duration comes in. Long-term bonds have higher duration, so their prices and yields are more sensitive to changes in expected future rates over the whole horizon. If markets think the Fed will cut a little and then stop, the long end doesn’t move much. With a positive term premium, the 10-year stays sticky, even as the Fed lowers the short end.
Mark Fleming - Exactly. The short end reacts quickly because it’s tied directly to policy. The long end is like steering a cruise ship, it takes a lot more to move it.
Odeta Kushi - Which means if you’re waiting for a five-handle on mortgage rates just because the Fed is cutting, you might be waiting a while.
Mark Fleming - Spreads matter too. The Fed is still letting mortgage-backed securities roll off its balance sheet, which keeps mortgage spreads wider than they otherwise would be. So, even if the 10-year drifts lower, mortgage rates may not fully reflect it right away.
Odeta Kushi - Right. When the Fed was a buyer of MBS, that demand helped narrow spreads. With the Fed no longer buying, less demand keeps spreads wider, which is part of why we had those 3% or sub-3% mortgage rates back then.
That said, there’s a silver lining. Spreads have improved. They’re still not back to the historical average of roughly 1.7 to 2.0 percentage points, but they’re no longer above 3% like in 2023. Today, they’re closer to about 2.3 percentage points. The spread reflects lender risk appetite, market volatility, and prepayment expectations. It typically widens when uncertainty is high, pushing mortgage rates up even when the 10-year falls. In recent months, as uncertainty eased and expectations grew that slightly higher-rate mortgages will be refinanced over time, spreads narrowed.
So, what does this mean for housing? Even small rate declines matter in such an interest-rate-sensitive sector. We’ve already seen purchase applications pick up as rates moved toward 6%. Existing-home sales rose in July to about 4.01 million, then edged back to roughly 4.00 million in August. New-home sales in August increased to the fastest pace since early 2022.
Mark Fleming - I see a positive theme here: improvement regardless of rates. Builder sentiment is still subdued, but the future-sales expectations component ticked up in September. Inventory is growing, though that growth is slowing. Even if mortgage rates drift down only a little, sales could grind higher through the end of the year.
Odeta Kushi - And don’t forget adjustable-rate mortgages. Five percent may be unrealistic for a 30-year fixed right now, but ARMs are tied to short-term benchmarks, like the Secured Overnight Financing Rate (SOFR), so they respond more directly to Fed cuts. In MBA’s applications data for the week ending September 12, ARM share increased to about 13%, the highest since 2008. The average contract rate for a 5/1 ARM decreased to 5.65%.
Mark Fleming - And let’s remember, these are not the risky adjustable-rate mortgages from the Global Financial Crisis. Today’s ARMs are safe, bread-and-butter products. It makes sense that their share is rising. And it’s nice to see a five at the front, instead of a six.
But since we’re talking ARMs, let’s pivot to commercial real estate, because floating-rate loans are common there. Lower short-term rates immediately reduce debt-service costs for borrowers, especially in sectors like multifamily and construction, where financing costs have been a real pain point.
Odeta Kushi - That's right.
Mark Fleming - This immediately reduces debt service costs for borrowers with floating rate debt. And that's a big deal for sectors like multifamily and construction loans where financing costs have been a pain point recently.
Odeta Kushi - Exactly. While high long-term rates limit how much cap rates might compress, lower short-term rates give breathing room to borrowers. It’s not a full recovery story, but it’s a start.
Mark Fleming - So let’s play out two scenarios, Odeta. Ready?
Odeta Kushi - I'm ready.
Mark Fleming - Scenario one: the Fed delivers the two more cuts it’s signaling this year. Short rates fall further, but inflation pressures remain. The yield curve steepens, and the 10-year drifts toward 4%. Mortgage rates could move into the low sixes. That’s enough to encourage some buyers off the sidelines and improve sales, but not enough for a big refinancing boom. Remember, 81% of existing mortgages have rates below 6%. The average mortgage rate on outstanding debt is just 4.1%.
Odeta Kushi - Scenario two: Debbie Downturn again. The Fed pauses after this cut, short rates stabilize, the curve stays steep, and mortgage rates hover in the mid-sixes. Housing still improves from very low levels, but the pace is slower.
Mark Fleming - Exactly. Even in that scenario, we think sales rise from the trough. The biggest affordability shock was the jump from 3% to 7% in such a short time. Coming back to the mid-6s provides relief, especially with more inventory. But it’s not going to be all about rates.
Odeta Kushi - That’s right. And for buyers, timing the absolute bottom on rates is tough. If affordability works at 6.3%, waiting for 5.9% could mean missing the right home.
Mark Fleming - Exactly. For sellers, even a small rate drop can bring more buyers into the market. Housing doesn’t need a 5% mortgage rate to thaw. It just needs stability and a little relief. But most importantly, Fed rate cuts are not a cure-all. As we’ve said, this year’s activity will be driven by lifestyle choices—what we call the five D’s of home buying: diplomas, diapers, divorce, downsizing, and death.
Odeta Kushi - So here’s our bottom line. A cooling labor market prompted the Fed to cut rates and they’ve signaled more to come. But with inflation trending the wrong way, the long end of the yield curve may remain elevated. Markets are already pricing in more cuts, leaving limited room for further declines unless the data weakens significantly.
Mark Fleming - Right. So, can the FOM-C us through?—see what I did there? The point is, we can’t count on dramatically lower mortgage rates. But housing activity should still improve. Applications are up, inventory is growing, and builder sentiment is stabilizing because life happens regardless. For commercial real estate, lower short-term rates help floating-rate borrowers right away, even if valuations take longer to recover.
Odeta Kushi - Very clever, Mark. Very clever.
Mark Fleming - But one last thing, Odeta—when it comes to mortgage rates, we’re still waiting for a quote, “mortgage rate star to fall.”
Odeta Kushi - There it is!
Mark Fleming - See, I told you I’d sneak in another ‘80s reference. For those who don’t know, that’s from the 1988 Boy Meets Girl hit. Listeners, you have to look up the video—big hair, synthesizers, even a Polaroid camera. You know what that is, right, Odeta?
Odeta Kushi - Haha! I think I’ve seen one in a meme or maybe a museum. And before this gets any worse, let’s wrap it up. Thank you all for joining us for this episode of The REconomy Podcast. If you have an economics-related question you’d like us to feature, you can email us at economics@firstam.com. And, if you can’t wait for the next episode, follow us on X. I’m @OdetaKushi, he’s @FlemingEcon. Until next time.
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