The employment rate is one of the factors that the Federal Reserve considers when adjusting interest rates. While a strained labor market usually results in lower interest rates, a more robust job market can cause interest rates to swing higher. The U.S. central bank, a.k.a. the Federal Reserve, uses a variety of factors to set interest rates, but the relationship between the employment rate and mortgage rates underscores how connected economic indicators and the financial markets are.
The Direct Link: Unemployment Influencing Mortgage Interest Rates
Unemployment is an ancillary factor in how mortgage interest rates are determined because central banks use the unemployment rate to determine the amount and cadence of rate hikes.
The Crucial Role of the Federal Reserve
The Federal Reserve’s primary function is to promote the efficiency of the U.S. financial system through monetary policies that focus on balancing sustainable employment rates and inflation control. They achieve this through several activities, including regulating the banking system and being the last resort lender in case of destabilization.
How the Federal Reserve Uses Unemployment Rates
The unemployment rate is a significant indicator of the health of the labor market and the overall economy. High unemployment can indicate that the economy is underperforming, while low unemployment can indicate a stronger market, but wage pressure. Because the Federal Reserve’s role is to achieve sustainable employment rates, when unemployment becomes too high, the Federal Reserve lowers interest rates in hopes that job creation will increase. In the same vein, interest rates are increased when unemployment is low to blunt inflation. The Federal Reserve does not have an unemployment target in mind but uses it to analyze how the economy is faring.
How the Unemployment Rate Affects Mortgage Rates
Besides the Federal Reserve’s use of unemployment rates to adjust interest rates, the number of jobless individuals also affects the general economic outlook in the following ways:
1. Demand for homes. High unemployment usually lowers demand for housing. Prospective homebuyers may hesitate to take on such a long-term asset. This decrease in demand can cause prices to drop and influence mortgage rates.
2. Market perspectives. In a struggling economy, investors are more risk averse. Instead of investing in real estate, they may decide to place their money into safe-haven investments like treasury bonds. In periods of high unemployment, bond prices rise, but their yield falls. Because mortgage rates are often tied to these yields, they follow the same pattern.
3. Economic forecasting. Unemployment rates affect the perception of the economic outlook. Because mortgage rates are influenced by expectations of future economic conditions, high unemployment rates may indicate weakness and cause lower mortgage rates as investors avoid buying property.
How Did the COVID-19 Pandemic Impact Interest Rates?
The COVID-19 pandemic had significant impact on interest rates, as the central banks and world governments were forced to respond to the shifts in consumer behavior and income.
Economic Uncertainty
The mandatory lockdowns, travel restrictions, mandatory business closures from the pandemic caused a sharp decline in consumer spending, resulting in economic shock. In addition, job losses disrupted the labor market, and volatility within the financial markets brought stocks down and created uncertainty among investors.
In response to this upheaval, the Federal Reserve cut interest rates to 0% in March 2020 to stimulate the economy and promote less expensive borrowing. While lowering interest rates can free up money to circulate in the economy, it can also come with certain risks down the road, namely asset inflation.
The Mortgage Industry
One of the drawbacks of the lowered interest rates during the pandemic was asset inflation. The reduced cost of borrowing made real estate acquisition especially attractive to investors seeking rental income. In areas with strong rental markets, investor demand alone can cause soaring prices. During periods of low interest rates, even the ancillary activities taking place, such as homebuilding, speculation, and refinancing, may cause a rebound hike in prices.
What to Expect in the Future
While it can be hard to predict what the economy will look like in the future, the Federal Reserve and other governmental agencies try to project what’s ahead using current trends. Let’s look at what we might expect from both the labor market and the mortgage market in the years ahead.
The Unemployment Outlook
The Congressional Budget Office has offered its projections on several points of the economy from 2023 – 2033. At the end of 2022, employment was relatively low at an average of 3.6%. This rate was expected to increase throughout 2023 and settle around a 4.7% average. However, in 2024, the unemployment rate is expected to fall through 2027 with an average of 78,000 jobs added per month.
Labor force participation – or the number of people aged 16 and up who are employed, seeking, or available for work – will remain relatively unchanged through that same time period.
Mortgage Rates in the Future
The outlook for mortgage rates is generally positive with rates expected to decline 1% by the end of 2024. However, experts predict the path back to the much-extolled 3% rate seen in 2021 may take decades.
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