What happens when the Fed moves rates?

Consumers are often confused when it comes to the subject of the Federal Reserve and how it affects mortgage interest rates. Often the media is the culprit causing the confusion.  In the last few years, the Fed has taken action that caused mortgage interest rates to move in a direction other than what consumers expected, because the media provided weak reporting on the subject.

The Federal Reserve movements affect short-term interest rates: the Fed Funds rate, and the Fed Discount Rate (overnight lending rate).  These rates in turn have a direct impact on the Prime Rate.  However, the Prime rate affects commercial loans, credit cards, HELOC's and other short term loans.  Mortgage rates (long term loans) are dictated by the trading of mortgage-backed securities.  These securities trade in the "bond market" and not the stock market.                                  

The real dynamic at the heart of any interest rate movement at the time of a Federal Reserve rate cut is the relationship between stocks and bonds.  Stocks and bonds compete for the same investment dollar on a daily basis.  There is literally only so much money to go around.  When the Federal Reserve cuts interest rates in an effort to stimulate the economy, this reduction in rates often causes a stock market rally.  When the market rallies (stock prices move up) the money to invest in stocks usually comes from the selling of mortgage-backed securities.   Unfortunately, when Investors put their money into the stock market rally, the bond market suffers.  The bond market then has to increase their yields to Investors in order to compete for the same money... and this causes mortgage interest rates to go up, not down.

Conversely, there have been many times when the Federal Reserve has increased interest rates.  Stocks then "sell off" in fear that the increase will affect corporate profit margins, and that money will then run to the bond market (known on Wall Street as a Flight to Quality).  This "safe haven" is found in mortgage-backed securities... when money runs into these bonds, it causes mortgage rates to drop.  This daily "ebb and flow" of money in and out of the bond market is very, very important when it comes to the movement of mortgage interest rates.

So... the bottom line is that movements by the Federal Reserve typically cause home loan rates to move in the opposite direction from which the Fed moved.  Confusing, huh?

Lyman King
Senior Loan Consultant, CHUMS J127
(916) 961-0858  direct line

Metro Gold Financial

John Hayes

RE/MAX Gold

530-306-3316

www.johnhayesrealestate.com