How the Fed Impacts Mortgage Rates

The Federal Reserve Open Market Committee (FOMC) meets at least eight times per year to discuss and vote on US monetary policy. The Fed controls the Fed Funds rate, which is essentially a bank's cost of money. When the Fed increases the Fed Funds rate, short-term interest rates such as the Prime rate and LIBOR go up. These are often used to determine interest rates on adjustable rate mortgages, home equity lines of credit, credit card balances, and business loans.

However, interest rates on fixed-rate mortgages are not tied to changes in the Fed Funds rate.  Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market. When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other "securitizers". These "securitizers" get their money by issuing bonds to bond market investors.  These bonds are called "mortgage bonds" or "mortgage-backed securities". Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market. As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive interest rates down and stimulate the economy. Currently, the Fed owns a whopping $1.7 TRILLION in mortgage bonds!

In fact, the Fed has been the biggest buyer of mortgage bonds in recent years. This had the impact of keeping interest rates very low. In October 2017, the Fed began reducing their bond purchases, and as of October 2018, the Fed's mortgage bond buying program has undergone a near-complete wind-down. The Fed is now only buying $300 million of mortgage bonds per month, compared to last year's purchases of approx. $1 billion of mortgage bonds per day. This massive wind-down of the Fed's bond-buying program has been a major contributing factor in driving up mortgage rates by over 1% in the past year. The trend toward higher rates is likely to continue.

Please contact me for further details or for a real-time analysis of how mortgage bonds are trading today.