Why Are Interest Rates So High?

I’m not an economist so I don’t plan to go into great detail but I know that some of you have questions and are afraid to ask. 

The long and the short of it is this: inflation.

But what causes inflation?  We hear about it on the news and in job reviews, you might ask for a raise just to “keep up with inflation.”  But what causes it?  And how does it affect mortgage rates?

SUPPLY AND DEMAND

This one’s easy.  When a lot of people want to buy something and there’s not enough supply, the price increases.  Like Taylor Swift concert tickets.  Or toilet paper during COVID.  Sometimes this is price gouging but it’s typically just the logical way to accommodate high demand, low supply.  Supply and demand is one reason we see price increases.

MONEY SUPPLY

When people have more money to spend, they often buy things that they otherwise wouldn’t.  During COVID, money was reallocated in household budgets because money wasn’t being spent on restaurants and vacations.  Instead, people spent money on physical items such as home exercise equipment and creating home offices.

SUPPLY SHOCK

This is often discussed when there’s a natural disaster, war, or “act of God”.  An example might be the war in Ukraine or a fire at an oil refinery.  Oil and other fossil fuels are crucial to the production of goods across the world.  A shortage of oil means a shortage of goods produced with them.  A shortage of goods makes prices—you guessed it—increase.

In a nutshell, to curb spending so that prices come back down, interest rates are raised.  Raising interest rates is a way for banks to get us to stop spending so much money (theoretically).

So when the Federal Reserve (Fed) starts charging banks more money for overnight loans, the banks pass that increase along to consumers.  The rate at which the Fed lends money to banks is called the “federal funds rate.”  Typically, the federal funds rate and mortgage rates move in the same direction, but not always.  This is why a “rate hike” or a “rate decrease” to the federal funds rate doesn’t always mean the same thing will happen with mortgage rates.

The Fed’s target rate for inflation each year is 2%.   Hopes were high in January of this year when inflation got down to 3.09% from 2023’s high of 6.41%.  There was even talk in January of rate cuts.  Unfortunately, we were back up to 3.48% in March this year so rumor on the street is that if there are rate cuts to be had in 2024, they will be small and they will come later in the year.

I hope this helps make sense of the jargon that is so easily tossed about but not always explained.  Send us a message if you have questions- we’ll do our best to find you the answer!