The fed does not control mortgage rates

The Fed Does Not Control Mortgage Rates

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If you ever want to bore everyone you know, start talking about the Federal Open Market Committee and monetary policy.

I know this from experience.  I may not be invited back to Thanksgiving next year.

But, tomorrow morning, you will read the headlines on the front page of your local newspaper:  Fed Leaves Rates Unchanged.

It's important to understand how the Fed's decision to hold the Fed Funds Rate at 5.250% impacts mortgage rates and the answer may surprise you -- there is no relationship at all.

The Fed Funds Rate is a short-term interest rate and it's premier implication to the economy is that it makes borrowing money from banks more expensive.  Prime Rate is based on the Fed Funds Rate and is always 3 percentage points higher than the central bank's benchmark rate.

Business owners and homeowners are familiar with Prime Rate -- it's the rate upon which credit lines and home equity lines of credit are based.  As the FFR increases, so does Prime Rate, and by association, so does the cost of short-term borrowing in our country.

Mortgage rates, on the other hand, are determined by the mortgage-backed securities market and most of these bonds are 30 years in duration, whether they are fixed rate, or adjustable in nature.  Mortgage-backed bonds are considered long-term products.

Short-term versus long-term.  Two totally different markets.

Have I bored you yet?

If so, let me jazz this up with the graphic from HSH Associates aboce.  The graph shows that -- over the last three years -- as the Fed Funds Rate has increased, the 30 Year Fixed Rate Mortgage has remained relatively flat.

There is no direct link, in other words.

Long-term rates are governed by the overall health of the economy, and the expectations of future growth.

For this reason, what the Fed said today is much more important than what they did (or didn't do).

The Fed's press release discusses their position on inflation, on housing, and on the growth of the United States economy.  Because the Fed slightly shifted the long-term expectations of the economy to the "slow" side, long-term securities (including mortgage bonds) are coming down in yield (i.e. rate).