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Fed target rate down, mortgage rates up

So over the last 2 week the FED has cut their target interest rate a full 125 basis points and credit demand has plummeted off a cliff. Guess what 30 year mortgage rates are pretty much unchanged from a week ago after initially dropping after the cuts. Below is a chart showing the relationship between the effective funds rate (which the FED tries to hold to the target), the ten year treasury and 30 year mortgage rates. It also shows the spread between the 30 year mortgage rate and the effective funds rate (wrongly labeled as FFR on the chart)

This very clearly show the dropping over overnight lending rates has a relatively small effect on fixed mortgage rates, the spread is widening. I expect the spread will continue the trend of widening and despite further reductions in the FED target rate, mortgage rates will more than likely rise over the coming year.

Posted by Matt Heaton on 02/02/2008 01:05 AM

Comments (10)

mortgage rates, the fed, credit markets

10 Comments on Fed target rate down, mortgage rates up

FEB

2008

Party Pooper! Nice to have you back home. Hope your trip was an enjoyable one!

Matt... Why do you think the Fed dropping its rates is not having the intended effect on the 30 year mortgage rate ? Is this response different from that of previous years when the Fed dropped the rate ? Thnks for sharing...

The FED doesn't really have control over long interest rates, they are set by the market. As investors continue to determine that mortgages are riskier debt they will continue to ask for a higher interest rate spread to compensate. I would not be at all shocked to see the average 30 year interest rate back above 6% by years end even with a Fed funds target below 2%

Rich, yup I've been away for a little bit, so I've got a bunch of depressing economics posts saved up. You know me, I'm always the optimist :)

I'm not going to buy into this ....where's the Rich and Bob posts????? lol!

Okay....so the only reason for the drop is so all the LO's can call me and ask ...hey....do we have any past client's who need to refi?

Matt... being the optimist, you are "positive" the market will continue to suck. Sounds pretty positive to me... LOL. I cannot remember a time when the 30 year rates did not follow... more or less... the Fed rate dropping. So I guess what you are saying is that the negativity of the market is much stronger at present than it has been during recent periods when the Fed's dropping of the rate produced a corresponding drop in 30 yr rates... so that it is having little, if any effect.

Karen, remember that just a couple years back when the FED funds target was 1% the 30 year rate was just barely under 5%, so this is actually fairly typical historically. It's not just negativity in the market, but the fact that very little premium has been accessed for risk the last several years on loans and this is starting to rapidly change. Spreads on all debt is widening substantially. For example in the commercial real estate space we've seen spreads widen on loans as much as 10% in just six months. Incidentally the (ka)boom in the commercial real estate space in not very far off.

Matt, I agree with you and expect to see this gap widen as well. I'm waiting also to see what's going to happen in the commercial real estate markets. I've been reading lately that they will not have an issue, but neither see nor believe that. I've been expecting a downturn by summertime if not sooner, but...

Commercial real estate is going to have huge problems. Historically the downturn there has lagged residential real estate by about a year. The leverage used in that space makes the lending in residential real estate look pretty sane.

Take a look at the CMBX indices that track the spreads for commercial real estate debt. The higher it goes the more the players in the commercial space pay, the problem should be pretty visually obvious.

http://www.markit.com/information/products/cmbx/history_graphs.html

Matt, I know what you're saying and totally agree with you. Just looked at the indices - wow! Thanks for attaching that.

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Fed target rate down, mortgage rates up

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