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Note:
This is a simplified discussion of a very complex
topic. Discussion of the intricate relationships
involved, and many important factors (market
structures, hedging, advance commitments, and
others) haven't been included in the text in order
to make this useful to the greatest number of
people.
Contrary to popular
myth, the Fed (more properly, the Federal Reserve)
does not control mortgage rates. In fact,
their most well-known policy tool -- the Federal
Funds rate -- is the overnight interest rate which
banks charge each other when a bank needs to borrow
money to meet end-of-day reserve requirements.
Simply, those rules say that a bank must have so
much cash on hand when the books close at the end of
the day, and those funds can be borrowed from
another bank at this interest rate. You should know
that the Fed merely "suggests" what that
rate should be, which is why it's called a
"target" rate; the actual rate is
negotiated between the borrower bank and the lender
bank.
A good way to keep a
handle on the Fed is to remember that the Fed Funds
rate is the shortest of short-term rates --
literally, an overnight loan -- and a fixed-rate
mortgage is all the way at the other end of the
scale, a loan that lasts as long as 30 years.
From Fed Funds moves,
there's a complicated discussion of monetary policy
about how Fed moves affect certain deposit and loan
markets and inflationary expectations. We'll leave
that for another article.
The end result is
that the Fed raises or lowers interest rates to help
address increases or decreases in economic activity.
Lower rates can help banks to make certain kinds of
loans less expensively, especially for business and
certain kinds of consumer lending, and that can help
to generate greater economic growth. Higher rates
can cool demand, helping to keep inflationary
pressures from forming.
In some ways,
expectations of what the Fed might do, can be more
important than what the Fed actually does, as their
actions or inactions can help to confirm or deny
what investors believe.
You may also have
noticed that sometimes the Fed cuts interest rates
-- and fixed mortgage rates actually rise as a
result. Why? If the Fed is taking steps to address
economic weakness by lowering rates, that likely
means that a return to faster growth -- and possible
higher inflation, as well -- is coming sooner,
rather than later.
So what moves
mortgage rates? Supply. Demand. Competition for
money. Inflation. The Economy. Expectations. And
you, of course.
We hope that this
helps you understand a little better how the whole
thing works.
The
purpose of this newsletter is to stimulate thought
for our clients and those professionals with whom I
network. One should consult with a qualified
mortgage professional prior to implementing
any mortgage planning strategies. If you are a
financial planning, insurance or real estate
professional, a CPA, or legal professional receiving
this newsletter or know of one, please contact my
office to introduce yourself and your services to
me. I'm always seeking to grow my referral
network and expose professional services to my
client base. I specialize in helping those
individuals who are seeking to buy, sell or
refinance real property. |
