30Apr2013
Dan Green
Author
Dan Green
Filed Under
Federal Reserve

Mortgage Rates : What Will Happen After The May 2013 Fed Meeting

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Comparing the Fed Funds Rate to 30-year fixed rate mortgage ratesThe Federal Open Market Committee (FOMC) adjourns from a 2-day meeting Wednesday, its third of 8 scheduled meetings for the year.

The FOMC is expected to leave the Fed Funds Rate unchanged near zero percent. That doesn't mean that mortgage rates will stay unchanged, however.

To the contrary, mortgage rate may move by a lot.

Click for pre-FOMC mortgage rates.

Mortgage Rates : Not Under Federal Reserve Control

Know this: The Federal Reserve doesn't set mortgage rates. Mortgage rates are based on the price of a mortgage-backed bond, plus whatever loan-level pricing adjustments which apply to your individual situation, plus whatever g-fees are being charged.

These mortgage bonds that link to mortgage rates are securities and trade just like stocks. Buyers and sellers agree on a value, and make a trade. As market conditions change, so do mortgage rates.

Mortgage bond prices are based on supply and demand. When bond prices rise, it means that demand is outstripping supply, which leads mortgage rates lower. When bonds prices fall, it means that supply outstrips demand, which leads mortgage rates up.

All of these changes, of course, occur outside the purview of the Federal Reserve.

The Federal Reserve does not tell traders what a mortgage bond is worth. Ergo, the Federal Reserve does not set mortgage rates. Mortgage rates are a function of Wall Street.

Click for pre-FOMC mortgage rates.

Comparison : Mortgage Rates Versus The Fed Funds Rate

There is no correlation between the Fed Funds Rate and consumer mortgage rates, nor is there causation. When the Fed Funds Rate rises, there's no telling whether mortgage rates will rise along with it, nor whether mortgage rates will fall.

The relationship between the Fed Funds Rate and mortgage rates is indirect.

Since 2000, the difference in interest rate between the Fed Funds Rate has been as low as 0.53% (January 2001) and high as 5.29% (June 2004). The spread can swing wildly, too, from year-to-year :

  • Years with a 5 percentage point differential or more : 2002, 2004, 2009
  • Years with a 1 percentage point differential or less : 2000, 2006

Furthermore, if we go back to 1973-1974, and to 1980-1981, the spread between the Fed Funds Rate and the average 30-year fixed rate mortgage rate went negative. 30-year fixed mortgage rates were higher than the then-current Fed Funds Rate.

The data illustrates how the Fed Funds Rate moves independently from mortgage rates. If there was correlation or causation between the two, the long-term interest rate spreads would be linear. Clearly, it's not.

Click for pre-FOMC mortgage rates.

The Fed Can *Influence* Mortgage Rates

So, the Fed can't set mortgage rates. However, it can influence them, however. And for that, rate shoppers will want to be prepared.

At 2:00 PM ET Wednesday, the Federal Reserve's Federal Open Market Committee (FOMC) will release a statement to the markets in which the group is expected to do 3 things :

  1. Leave the Fed Funds Rate in its target range of 0.000-0.250%
  2. Change the verbiage of its statement to acknowledge the improving U.S. economy
  3. Re-iterate its commitment the group's third round of quantitative easing (QE3) to support the bond markets, low mortgage rates, and the housing market, in general

The first action -- leaving the Fed Funds Rate unchanged -- will have no effect on markets. That much is expected. The Fed Funds Rate has been near-zero since late-2008 and the Fed has been clear that the rate will stay near zero for the foreseeable future.

The second action -- changing the verbiage in its statement regarding the health of the U.S. economy -- may have a negative effect on rates. This is because the Federal Reserve has said that it will start discussing an increase to the Fed Funds Rate once the national Unemployment Rate reaches 6.5%, so long as inflation pressures have remained low.

When the Fed raises rates, it signals an improving U.S. economy, which tends to aid stock markets at the expense of U.S. bonds. When bond markets fall, mortgage rates rise.

It's the third action, however, that's the big one.

The Federal Reserve launched QE3 in September 2012, promising to purchase $40 billion of mortgage-backed bonds monthly for "as long as necessary". In buying such volume, the Fed created demand-side pressure which raised MBS pricing, and lowered U.S. mortgage rates.

As the economy recovers, though, the Fed recognizes a reduced need for its stimulus. There is still no clear "end date" for QE3, but Wall Street is a world of speculation and speculation moves markets.

The Fed likely won't use its statement to name a date on which QE3 will end, but the omission won't stop investors from guessing. If the herd believes that QE3 will terminate within the next 6 months, mortgage rates will likely rise tomorrow. If QE3 is believed to extend into 2014 and beyond, mortgage rates will likely fall tomorrow.  

It could be a wild day for mortgage rates.

Your Rate Lock Plan For May 2013 FOMC Meeting

If the mortgage rate on your loan is not yet locked, consider getting in gear. There's little room for mortgage rates to fall, and plenty of room for rates to rise. It's a gamble for which you don't want to guess wrong.

The Fed does not set mortgage rates, but its policies can make mortgage rates move. Protect yourself. Get a mortgage rate quote now.

Click for pre-FOMC mortgage rates.

About the Author

Dan Green is a mortgage market expert, providing over 10 years of direct-to-consumer advice. NMLS #1019791. You can also connect with Dan on Twitter and on Google+.

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