In this week’s episode of Optimal Insights, host Jeff McCarty is joined by Alex Hebner, James Cahill, and Kevin Foley to unpack the Fed’s recent 25-basis-point rate cut and its ripple effects across the mortgage and treasury markets. The team explores the implications of rising interest rates despite the cut, investor sentiment, and the looming debt refinancing challenge facing the U.S. government.

A central theme is the Fed’s “third mandate” – moderate long-term interest rates – and how it’s being interpreted in today’s economic climate. The discussion also touches on inflation expectations, political pressures, and the potential impact of a government shutdown on mortgage operations.

Key Topics Discussed:

• Fed’s 25-basis-point rate cut and market reaction
• The disconnect between short-term and long-term rates
• Debt refinancing pressures and political incentives
• Inflation expectations and business sentiment
• The Fed’s third mandate and its evolving role

Tune in to gain valuable insights to help you stay ahead and maximize your profitability in the ever-evolving mortgage landscape.

#ModernProven

Optimal Insights Team:

• Jeff McCarty, Vice President of Hedging and Trading Product, Optimal Blue
• James Cahill, MSR Account Manager, Optimal Blue
• Alex Hebner, Hedge Account Manager, Optimal Blue
• Kevin Foley, Director of Product Management, Optimal Blue

Optimal Blue Production Team:

• Executive Producer: Sara Holtz
• Producers: Matt Gilhooly & Hailey Roise

Commentary included in the podcast shall not be construed as, nor is Optimal Blue providing, any legal, trading, hedging, or financial advice.

Mentioned in this episode:

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Summit - OI

Welcome to Optimal Insights, your weekly source for timely market analysis and expert commentary from Optimal Blue. I'm your host, Jeff McCarty, Vice President of hedging and trading product at Optimal Blue. Our clients and industry partners have long relied on Optimal Blue for trusted insights and commentary. And these podcasts are an evolution of our commitment to keeping the industry informed. Let's dive into today's episode. So we've got a great episode today.

obviously a lot to talk about coming out of the, the fed announcement to cut rates last week and then the corresponding rise in interest rates. as we kind of foretold in some of our previous podcasts, we thought that might happen. we've got the 10 year at 4.14 this morning, the OBMMI at 6.268, as of end of day Friday. again, you know, rates jumped.

a little bit over the past few days after the Fed announcement. So we're going to dig into that, talk a little bit about what might motivate that and some of the motivations of the Fed and some other industry players going forward. So excited to talk with Alex, James and Kevin today. So let's jump right into it.

All right, welcome Alex, Kevin, and James. Thanks as always for being here. So let's get right into it. Alex, maybe you can just kick us off with what actually happened with the Fed announcement last week and any key initial takeaways there.

Yeah, absolutely pleasure to be here and

Last week, the highlight of the week was really the Fed announcement on Wednesday. It came in where the market was expecting it to at a 25-base point cut. I think the biggest takeaway was that Stephen Meyrens was the sole voter for a 50-base-point cut when the rest of the board aligned, kind of unified, maybe on some political grounds. It's kind of wishy-washy on that. think they truly thought 25-base-point was the risk averse.

cut to make, address some of the labor concerns in the market without really expending a lot of that ammunition that they would have larger downturn.

And we just saw some comments come out just before we started recording from for even more aggressive rate cuts. And he argued for essentially a 2 % cut in rates.

bringing that down, that's nowhere near on where the dot plot was that we got. think he needs to do a lot of convincing on the board right now with who he's talking to.

But his argument is just kind of the classical argument is that people are paying too much attention to inflation and not enough attention to the risks of the employment situation.

Yeah, they seem to be comfortable with the 3 % or thereabouts, maybe a little under right now inflation target. I think that's perfectly politically sustainable, especially after the last few years. 3 % feels pretty tame. yeah, they seem to be fully pushing on the labor front as the main concern on the economy getting what they need to be back to full employment. We saw some drama around H1B visas this weekend. Trump's saying upwards of $100,000 per visa.

will really throw a kink in the talent pipeline for a lot of tech companies in particular.

Yeah, that was an interesting announcement. The details, know, it seems like the details are a little bit up in the air and obviously there'll be some lawsuits that gets figured out in the coming months. But that is definitely one to keep an eye on in the coming months.

let's dig into what happened after the Fed announcement a little further. As we've been preaching, Fed funds rate target is not indicative of other rates in the market, so the 10-year and obviously mortgage rates as measured by the OBMMI.

And we kind of had this perfect example over the past few days, right? So fed announces a cut in rates and we've seen the 10 year and the up about a 10th of a rates over the past three or four days.

Yeah, overall, it seems like a very, very similar story so far to last year where we had rates dropping, OBMMI dropping in anticipation of a September Fed cut. then shortly thereafter, starting to see the 10-year rise, although it's been fairly muted so far, I think, still awaiting some of the big economic data this week. We have PCE.

later this week. And we've also got revised Q2 GDP numbers. have ⁓ September non-farm payroll coming up in the next couple of weeks. So maybe some market participants still waiting to see what the next batch of data looks like post Fed rate cut.

would know is what you're saying there, Kevin. It brings us back to what we've been talking about, how one, the long end of the curve does not directly follow the short end of the curve. it also shows that there's potentially some shakiness out there from bond investors and that they may not 100 % agree with the direction the Fed is taking things.

Kevin, I think that kind of tees up to something you wanted to talk about that the short-term interest rate is really controlled by the Fed. That's what everyone is watching. That's what we're talking about every time the Fed goes to cut. But the long-term interest rate is a lot more controlled by investors and how they feel about the government, how they feel about debt, how it's going to get paid. And that tenure in the middle is really the spread between the two. It's what's going on in that middle term. And we've had some kind of interesting thoughts thrown around from administration and other economists just

about what's going on with the 30 year and how the Fed could maybe act differently to try and help those middle and long-term interest rates.

Yeah, I know we, you some of us were talking here recently, there a third of all outstanding US debt needs to be refinanced in the next, was it 12 months or so? so I think there, there is, you know, some political pressure involved in trying to refinance that debt at more favorable terms, you know, which ultimately, know, has an impact in the bottom line of,

US Treasury and ultimately benefits the US economy. But in order to do that, that's a little tricky because normally that refinance rate is going to be dictated by market there's obviously a big political incentive to try and get that a bit more in favorable terms, which seeing inklings of that from the administration. I know Alex, this is something you've been following pretty closely as well.

Definitely. I ⁓ think it's been explicitly stated on just a handful of occasions now, but they're definitely interested in refinancing that debt at the lowest possible rate that they Our debt to GDP ratio, as we've talked about, I think a couple of months ago now, was big on it a few months ago, but ⁓ we're second only to a couple of fully developed economies, such as Japan. And while we do have the kind

you know, know, you know, keeping government spending in check. That's not what we've seen, you know, from either side of the aisle over the past 15, 20 years now. it's just really interesting. And I think maybe there are some alarm bells that they don't want to explicitly, you know, put out there in the news. But I do think that there's maybe there is a point where we're well over 100 % debt to GDP ratio at this point. then,

was around 10 years ago or so, I talked about this in a LinkedIn post a while back, one of the most stable holders of ⁓ US government bonds are central banks in other countries who are using US treasuries to balance the valuation of their own currencies against the US dollar.

And so that's created this additional sort of glut of a US debt that is going to other institutions, which are in some cases more likely to sell or buy based on market conditions other than that more stable component of demand to prop up currencies. definitely going to be an interesting story to watch over the coming months as

We see a lot of this playing out both in Washington and in the markets.

just to tag a couple of the numbers that Alex and Kevin, you guys were kind of stepping I saw that the average rate of the debt right now is about 2.7%. And so one third of it is gonna need to be refinanced this year. We have a couple of months left. It's gonna be refinanced at roughly gonna add about $300 billion to the servicing. So it's definitely, it's more than I'd care to throw around.

who owns the debt is something I always kind of look at. It is roughly 60, 70 % of it is owned by the United States, our own government, citizens, private equity, investors. It's roughly 25 % is owned by the rest of the world. And kind of the big players that you would think it's Japan, it's China, it's the UK combined, they own less than 10%. So I'm always a little surprised by that. I think of who owns our debt, really think of like,

probably Japan and China own half of it. It's not even remotely close to that. So that's always, you still got to pay it, but it's comforting to know at least it's us.

Yeah, every now and then you hear concerns around the debt bomb or what happens if there's a mass liquidation of foreign holders. But I think coming back to what we're talking about, the main concern here is that servicing. And as with any lending, lenders are concerned about, I going to get my money back? And at what rate of inflation? think inflation is definitely a concern for them.

Yeah, it's a super interesting stat.

And then, know, know, distantly speaking, you know, decades down the line, they're asking themselves, am I going to get paid in full in 30, 40 years? I think the United States absolutely will be here in 30, 40 years. But this is a, you know, when you're investing in other countries, you know, the world, that that is a concern. And still something that factors into all their models.

Yeah. I guess so like to bring this back to kind of where we started, we the Fed cut week. We have this sort of looming debt refinance over the next year or so. the terms ultimately, which were that debt is going to be refinanced is sort of going to be determined in some cases by how fast and how far the Fed is cutting and then how markets are responding to that.

know, Alex, you're, you're sort of teeing this up is, now that we're post-cut, we're in a, we're in a post-cut world. big question is how, how fast and how far are they going to go? And it's really kind of all over the place. you look at the dot plot, which, which you reference Alex, which shows where the, ⁓ the different members of the, ⁓ the federal reserve board, I expect interest rates to be, you know, going out in time and it's anonymous.

So we can't see who's plotting which dots, except there is one that was very far below the other ones. And we can all kind of assume that that's Stephen Myron, out there arguing for the biggest cuts of all. we are sort of entering this new environment. We have a new term as well, risk management cut. not really sure what to make of that. Is that hawkish or dovish?

Thanks

But guess ⁓ time will tell as the next round of data unfolds. we really are entering this ⁓ new era now that we had this certainty around near market certainty around the Fed rate cut. We're getting into a much more ambiguous environment. And potentially, that's why we're seeing rates pull back a little bit because of that level of uncertainty post rate cut. But not sure what you guys are thinking about as we're going forward in time.

know what the next chapter may hold.

Yeah, I I was kind of looking around at it. What might they be looking at is to establish this 2 % as ideal target rate. And actually, that's right where we were in 2019 pre-COVID. So there's potentially a historical basis there. We didn't spend long there, is the thing. We had just kind of rocketed up off the zero lower bound after close to a decade of zero interest rates after the global financial crisis.

to ⁓ tag in on that. So

If we want to get to that 2 % and call that the average, that's definitely an outlier within US history, that 2%. And something to consider within that 2 % is every time we had a number like that, we also had quantitative easing happening. So the Fed was going out and buying bonds and helping to force those rates down. that's something that the best in the administration have said they're actually very wary of doing. But if you're not going to step in and become the buyer and start

purchasing mortgage bonds, starting to purchase treasuries, it seems very difficult to get to that 2 % as the average rate. It seems difficult to do that without very much driving inflation.

Yeah, I want to explicitly just call out one thing, which is kind of the third mandate of the fed, which calls for moderate long-term interest rates. James, you talked about average, so, you know, moderate average, what is, what is moderate or what does average mean? there's a lot of leeway for, for interpretation there about what that means, depending on, on what your goals are.

certainly, what are the Fed's goals relative to the administration's goals? I thought that conversation on all this debt that we have, outstanding debt we have out there really sets the stage really well about what are people's incentives right now to define what moderate means.

Yeah, and to pick up on that, Jeff, Stephen Myron came out recently talking about that third mandate, is sort of, is part of the Federal Reserve statute, but we typically think about the Fed's mandate in terms of its dual mandate of inflation and unemployment, but

part of what they're chartered to do. say moderate long-term interest rates, there's a lot of wiggle room around there. There's a lot of, in my opinion, fairly legitimate criticism around the Fed and the extent of their role. We've had this whole period pre-pandemic with QE

MBS, which obviously is, you it was beneficial for our industry for a long time. And now we're sort of feeling the drawdown of that. whether, you know, it makes sense for the Fed to get into these, you know, these other areas. but what's interesting about it to me, and I know I mentioned to you guys, I recently finished a book called The Price of Time, which came out a couple of years ago. that's by

Edward Chancellor. found it pretty interesting. It's a dry. We'll talk about the history of interest rates, of fast forward to a lot of the, you know, 20th century and getting into the 21st century, a lot of a lot of the criticism is, is around the risks of keeping interest rates too low. And what that does to the economy and how that sort of distorts investment causes asset bubbles, you know, a lot of things

sort of familiar with if we're watching the markets closely. And one of the arguments that it made also was in the run up, in the post.com boom bust, there was kind of lot of pressure on the Federal Reserve to keep interest rates low. And that pushed a lot of investment out into higher yield, more risky investments and was one component of setting the stage for ultimately the Great Recession. I think

that as well. And that really ties up into the whole question of what's the role of the Federal Reserve? How much should they be really pursuing goals aggressively or moderately? And what should the stance be? And we're really seeing a lot of that playing out right now the variation of voices that we have in the Fed now, especially with Myron who's a bit of maybe, I don't know if this is

He would appreciate this term or not, but a bit of an iconic class, at least in my opinion, very smart guy. He had written the guide to restructuring the global financial system, which set the stage for a lot of what the Trump administration has been doing this year from a global trade perspective. we are in this time period where there's a lot of these very varied forces at play and we're really having arguments about very fundamental things.

not really like, you know, nitpicking here and there, but much more fundamental things about who should the Fed be, you know, how should we think about setting interest rates and, know, ultimately, who gets to decide that.

All set.

Yeah. Yeah. It's going to be interesting to watch as, as always, where, know, there's, lot of moving parts here. So, so we've talked a lot about, the debt, talk about something kind of upcoming in the very near future and how that might affect things. ⁓ we've got the looming government shutdown, coming up at the end of the month. so, so what are we watching for over the next 10 days here? Really?

⁓ The argument right now is on the Hill, the Democrats are trying to fight for a little bit. There's a tax credit on health and human services as well as ⁓ Medicare that's going to be expiring. So they're trying to push to keep that as well as they want an assurance that the current lineup of where money is allocated will stay as it is. So it won't be pushed around any.

that is what they're the hill that they're going to try and die on. Ironically, if the government shuts, then the treasury can only fund money to the current allocations. So it would actually work in their favor. On the flip of that is it would give the administration a lot of power to decide who is, you know, a important individual who can and can't be furloughed. So they could kind of ⁓ pull little doge move, which is probably

coin flip that the House and the Senate are sitting on right now. come September 30th, we will hit a ceiling and they will need to decide how to continue funding the government. And if that doesn't go through, it's always kind of a disaster for people all over America.

Yeah, it's never pretty. There's going to be a lot of finger pointing, obviously, over the next couple of weeks. think we've kind of built out the playbook and been through several times over the years before in the mortgage industry in particular. You're going to have a slowdown of things like IRS tax parts of the underwriting loans.

Will sometimes get slowed down So, you know kind of dust off those playbooks as you're thinking about how it's gonna affect your day-to-day in the mortgage industry

In terms of rate volatility, it's probably not going to too much. Probably more operational as we go through that in the next several days. But something to keep an eye on.

What else we got hanging out there over the next several days in terms of economic data, Alex?

I say the big thing for this week, there's a lot of speakers from the Fed this week, just throughout the week, sprinkled throughout their blackout period from this Fed meeting. As we've touched on quite a was talking during, while we've really been recording here, he started speaking just before we began recording. So would absolutely say that it's worth checking out his comments. And then the big data release for the week is going to be PCE, again, that's Fed's preferred inflation metric, and that comes out on Friday.

Yeah, we had the St. Louis fed president speak earlier this morning, talked about, last week's cut being precautionary, which kind of goes along with that risk management take as well. and called policy between modestly restrictive and neutral. That was just a good way to frame it of where we're at. Right. So that, you know, on the average, going to see a few more rate cuts to get to a neutral rate but.

again, probably, you know, see how many of the Fed governors start to look more towards a more aggressive rate cut strategy.

Yeah. One other metric just to throw out there, which I think is important to track, but may not be on a lot of folks radars Atlanta feds business inflation expectations. And those are published on a monthly basis. So you kind of have the two components of inflation, which are what is inflation actually, and then the business inflation expectations are forward looking based on a survey of your business leaders.

around what they expect inflation to be over the next 12 months. the reason why I point these out is because I think it's a fairly interesting to watch. We're all sort of aware that tariffs are sort of starting to make their way into inflation numbers a little bit. But there's a big question of to what extent see that happen. And then does that end up creating long-term inflation expectation pressure? And so far,

expectations have held pretty steady over the last several months at So even though we are seeing a bit of uptick in inflation data, think headline coming out of that is that doesn't seem to the dial up in terms of what those expectations should be making that more of a long-term issue.

We're still in this period where it's really more of a short-term concern. businesses need, they're they're one-time price increases, assuming that they're stable sort of from here on businesses are starting to slowly eke some of that, ⁓ those price increases back to consumers. But the thinking so far is that that tap should turn off at some point, whether that holds steady or not.

yet to be seen, but that business inflation expectations metric is something that, my opinion, is pretty important to keep an eye on as we rounded the Q4.

One last comment on inflation is that we just all seem to be getting a little bit more comfortable 2 % inflation. And ⁓ we'll just round that down and call that 2%, guess at this point. was a good question Powell from a reporter.

pointing out that he keeps talking about, we'll get it down to 2 % in a couple of years, we'll get it down to 2 % in a couple of years, but never actually do. asking if that 2 % target is actually achievable. Anyways, plenty governors still keep pounding that, but we'll see how much the other side, how strong that voice grows. And of course, watch the employment situation closely.

Good. All right. Anything else?

Yep,

just looking for a two handle.

Yeah, yeah, two handles good enough, I guess.

All right. Thank you, Kevin, Alex, and James, as always, for your insights.

Thanks, Chef.

Awesome, great to chat guys.

That's it for today. Join us next week for another episode of Optimal Insights, where we'll continue to provide you with the latest market analyses and insights to help you stay ahead. Check out our full videos on You can also find each episode on all major podcast platforms. Thanks for tuning in to Optimal Insights.