If the Fed is Easing Rates, Why are Mortgages not Exactly Following?
We have been fielding calls over the last few months from clients who are wondering why, when the Fed has eased interest rates, mortgage rates have actually risen again after a brief dip over the summer. Great question!
To answer this, first know that the Federal Reserve (Fed) doesn't directly set mortgage rates. Its mission today is battling inflation and keeping the economy out of a recession.
Indeed, the Fed can influence mortgage market rates by expanding or shrinking its balance sheet, buying and selling huge batches of government securities in the open market, as it did during the financial meltdown / Great Recession 15 years ago.
While that's an example of how Fed actions can indirectly affect mortgage rates, clearly there must be other factors involved!
Federal Funds Rate:
The Fed sets the federal funds rate, which is the interest rate banks charge each other for very short-term (overnight) loans, as banks manage their daily cash flow. Mortgages, being longer-term debts, track more closely to the 10-year Treasury bond rates, which the Fed does not manage.
You can see this in the chart here - - note how mortgage rates track pretty closely to the long bond (10-year bond). Changes to the federal funds rate do make it more or less expensive for banks to borrow money. But it takes months for such changes to work through the financial markets and impact long-term bond rates.
Open Market Operations:
The Fed can buy or sell securities (like Treasury bonds) in the open market. You may recall “quantitative easing” being a part of the Fed’s response to the housing market crash around 2008. The Fed purchased over $1.5 Trillion of mortgage-backed securities, hugely expanding its own balance sheet.
By effecting massive demand for these securities, their price rose. In the inverted world of debt instruments, this lowered mortgage rates to help homeowners. Then it did so again in response to COVID-19, buying over $1T more! More recently the Fed has been trying to “unwind” its stuffed balance sheet by selling off debt, at lower prices, leading to (eek!) higher interest rates. Of course it has to try to do this carefully, or risk sending the economy into a recession. What a tightrope!
Additional Economic Factors
Mortgage rates have risen recently because other economic factors also have a powerful influence. Persistent inflation tends to devalue debt, since a dollar repaid in the future is worth less! That pushes down bond prices, and bond yields (interest rates) go up. Strong economic performance has the same effect. The bond market is focusing on these factors as they consider the prices they'll pay for long-term debt securities.
In sum, while the Fed strongly influences financial markets, its monetary policy actions only indirectly influence the markets for longer-term bonds that directly impact mortgage rates. Contact us for a more detailed discussion, and our thoughts about where rates may go from here!
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