When the Fed changes the federal funds rate, the policy rate itself does not directly affect very much. Almost no one borrows at the overnight rate. What matters is how the change propagates through the rest of the yield curve and into the borrowing rates households and businesses actually pay. The first and largest channel is housing.
Mortgage rates move with the 10-year Treasury yield, which moves with expectations of future short rates, which is exactly what the Fed influences. A 100 basis point cut in expected Fed policy typically pulls mortgage rates down by 60 to 80 basis points within a few weeks. That changes monthly payments immediately for new buyers and refinancers.
The transmission has three channels.
First, new construction. Builder margins are sensitive to mortgage rates because their buyers are. When rates fall, builder pipelines fill, lot purchases pick up, and within two to three quarters, housing starts and residential investment rise. Residential investment is small as a share of GDP, around 4 percent, but volatile, and the swings move the headline GDP number.
Second, existing sales and the moving-related spending around them. A house sale generates roughly 8 percent of the home’s value in associated spending: brokers, lawyers, movers, furniture, appliances, repairs. Higher transaction volume from lower rates means more of that ancillary spending, which shows up in retail sales and services.
Third, the wealth effect. Roughly 65 percent of US households own their homes, and home equity is the largest asset for most. When home prices rise because lower rates support demand, households feel wealthier and spend more out of current income. Estimates of the housing wealth effect run from 3 to 7 cents of additional annual spending per dollar of additional home equity. Across $30 trillion of US home equity, that is real money.
The same channels work in reverse when the Fed tightens. The housing market freezes first. Construction craters. Existing sales collapse and take the moving economy with them. Home prices flatten or fall, and the wealth effect runs in reverse.
This is why housing data leads. When the Fed pivots, you see it in mortgage applications, then existing sales, then starts, then prices, then construction employment, then everything else. By the time the broader economy responds, housing has been signaling for two quarters.
The Fed does not target housing. It targets inflation and employment. But housing is the lever that moves both.