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Does the Fed Control Mortgage Rates?

Mortgage Q&A: “Does the Fed control mortgage rates?”

With all the recent hubbub surrounding mortgage rates, and the Fed, you might be wondering how it all works.

Does the Federal Reserve decide what the interest rate on a 30-year mortgage will be?

Or is it determined by an open market, like other products and services, driven by supply/demand.

Before going into the details, we can start by saying the Fed does not directly set mortgage rates to consumers. But it’s more complicated than that.

The Federal Reserve Plays a Role in Directing Housing Rates

As noted, the Federal Reserve does not set loan rates. They don’t say, “Hey, the housing market is so hot, we’re raising your house prices tomorrow.” Sorry.”

That’s why the 30-year fixed rate started in 2022 at about 3.25%, and is now closer to 7% today.

However, the Fed meets eight times a year to discuss the state of the economy and what may need to be done to fulfill their “dual mandate.”

The so-called “dual mandate” aims to achieve two goals: price stability and sustainable high employment.

Those are the only things the Federal Reserve cares about. What happens because of achieving those goals indirectly the best.

For example, if they decide that prices are rising too fast (inflation), they will raise their overnight lending rate, known as the federal funds rate.

This is the interest rate that financial institutions charge each other when they lend out excess reserves. In theory, higher rates mean less borrowing, and less money flowing into the economy.

When the Fed raises this target interest rate, commercial banks also raise their rates.

So things happen when the Fed talks, but it’s not always clear and obvious, or what you might expect.

Perhaps more importantly, their actions are often known in advance, so lenders often start raising or lowering rates early.

What Does the Fed’s Decision Mean About Housing Rates?

The Fed Open Market Committee (FOMC) holds a closed, two-day meeting eight times a year.

Although we don’t know all the details until the meeting is over and they release their accompanying statement, it is usually sent over the phone.

So if they are expected to raise the rate of the funds being fed by another .50%, it is usually added to the rates of the loan already.

Or if they’re planning to cut rates, you may see lenders reset their rates in the weeks leading up to the meeting.

Since early 2022, they have raised the federal funds rate 11 times, from near zero to a target range of 5.25% to 5.50%.

When they raise this key amount, banks charge each other more money when they need to lend to each other.

And commercial banks will increase the prime rate by the same amount. So a 0.50% move in the rate of supply results in a 0.50% move in the prime rate.

As a result, anything tied to prime (like credit cards and HELOCs) will go up by that same amount.

But then, and this is a biggie, Mortgage rates will not rise by 0.50% if the Fed raises its lending rate by 0.50%.

In other words, if the 30-year fixed is currently priced at 7%, it will not automatically increase to 7.5% when the Fed issues its statement that it has increased the fed funds rate by 0.50%.

What the Fed Says or Does Can Influence Mortgage Rates Over Time

So we know that the Fed does not set loan rates. But as noted, what they do can have an impact, although it usually takes a long time.

A Fed rate increase/decrease is a short-term event, while mortgage rates are long-term loans, usually for 30 years.

That’s why they correlate better with the 10-year bond yield, since mortgages are typically held for about ten years before being refinanced or the home sold.

As such, tracking the mortgage rate is best accomplished by looking at the 10-year yield compared to the federal funds rate.

But if there is a trend over time, as there has been recently with hike after hike, both the federal funds rate and mortgage rates can rise in tandem as the years go by.

Finally, sometimes mortgage rates go up (or down) before a Fed meeting because everyone thinks they know what the Fed is going to say.

But it doesn’t go as expected. Sometimes the after-effect statement will be muted or the potential good news for housing rates, even if the Fed raises rates.

Why? Because the information may already be “baked in,” such as how bad news sometimes causes individual stocks or the market as a whole to rise.

The Fed Is Bigger on Housing Rates Lately Due to Quantitative Easing (QE)

Although the Fed plays a role (indirectly) in where mortgage rates go, it has played a more important role recently than at many times in history.

It’s all related to their mortgage-backed securities (MBS) that took place about ten years ago, known as Quantitative Easing (QE).

In short, they bought billions in MBS as a way to lower mortgage rates. A large consumer increases demand, thus increasing the price and lowering the yield (interest rate).

If the Fed’s meeting centers on the end of QE, known as “Policy Normalization,” or Quantitative Tightening (QT), mortgage rates may react more than usual.

This is the process of reducing their balance sheet by allowing these MBS to become active (by refinancing or selling the home) or until they are sold, instead of continuing to invest the proceeds.

Since the Fed mentioned this concept in early 2022, mortgage rates have been depressed, almost doubling from their levels below 3%. That was more of a driver than an increase in their price.

Mortgage lenders will be watching closely what the Fed says about this process, depending on how quickly they plan to “adjust.”

And how are they going to do it, eg by not reinvesting MBS funds, or by selling them outright.

They won’t really care about the feed rate hike, since that’s already been wired for a long time, and it’s already baked in.

So the next time the Fed raises its rate by 50 basis points (.50%), you can say that the Fed has raised mortgage rates. Even though 30-year mortgage rates are now 7.5%.

It’s technically possible, but not because the Fed has done it. Only because the market responded to the statement in the wrong way, by increasing prices.

The opposite may also be true if the Fed takes a softer-than-expected stance on their normal balance sheet. Or if they cut their level. But mortgage rates will not decrease by the same rate of depreciation.

By the way, mortgage rates may drop after the Fed issues its statement, even if the Fed raises rates.

(Photo: Rafael Saldaña)


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