Under Fed Chair Alan Greenspan (late 1980s to early 2000s), we also saw inflation rise from 1.75% to 3.5%. This took mortgage rates from 7% to 8.5%. Greenspan then hiked the Fed Funds Rate from 4.75% to 6.5% within a year. You guessed it, because of this, inflation dropped from 3.5% to 1% resulting in mortgage rates responding by dropping from 8.5% to 5.5%. Consequently, this also gave us another recession.
Our current Fed Chair, Jerome Powell, has seen inflation go from 1.5% to 8.5%. Mortgage rates went from 2.5% to 5%. Currently, the Fed Funds Rate sits around 1.75%. There is a possibility that the Fed could hike the Fed Funds Rate to 3% in 2022. Inflation should drop further and mortgage rates should decline as inflation goes down.
There is a pattern to be seen here and we will likely see another recession in either late 2022 or early 2023. Inflation is the arch-enemy of mortgage bonds. Typically, when inflation increases, mortgage bonds decline in price resulting in higher mortgage rates. When inflation decreases, mortgage bonds increase in price resulting in lower mortgage rates. Ultimately, when the Fed hikes the Fed Funds Rate, the bond market views this as deflationary and mortgage rates improve.