A Question Often Asked When the Feds Changes the Federal Funds Rate

The Federal Funds Rate is the overnight rate of interest at which Federal funds are traded among financial institutions. Federal Funds are non-interest bearing deposits held by member banks with the Federal Reserve. It is regarded as a key indicator of all US domestic interest rates.  When the Federal Reserve Board lowers the Federal Funds rate as in the unscheduled meeting last week, most mortgage loan officers start getting calls about mortgage rates.  Here is one of the most common questioned asked when the Federal Funds Rate is lowered.

Q: "I just heard that the Fed lowered rates by....  Does that lower my mortgage rate?"

A: "It all depends. In most cases the Fed's decisions are already known in the market far in advance of the announcement, so the change in mortgage rates would have already occurred in the weeks prior to the announcement.  In the rare case that the Fed surprises the markets (by the amount of the change or the fact that they made a change at all), you could see a change in Mortgage rates."

"The other factor to consider is that mortgage rates will move very different from Fed funds.  In some cases the opposite, in some cases more, and in some cases less."

 Here are 3 examples:

• The Fed lowers rates by 0.250%when the markets expected 0.500%. In a case like this, mortgage rates may decrease even more than the Fed funds change because the markets will think that the Fed didn't do enough to help the economy and so rates will need to go down even further.
  
• The Fed surprises the markets and lowers rates 0.500%.  In a case like this, the markets could think the Fed went too far and will over stimulate the economy and cause inflation. In most cases mortgage rates will go up if the market fears inflation, therefore mortgage rates would go up and move opposite the Fed funds change.
  
• Fed lowers rates by 0.075% as expected, but earlier than expected. The market could like the move, thinking the Fed did exactly what they needed to do and that they may not need to do much more. Mortgage rates may go down some, but since the market had already expected this change, the rates on mortgages will move less than the Fed funds rate change.