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Posted 09/20/2016

How Mortgage Rates Connect To The Fed Funds Rate

The Federal Reserve does not set mortgage rates

Mortgage Rates & The Fed Funds Rate

The Federal Reserve's Federal Open Market Committee (FOMC) adjourns from a scheduled two-day meeting Wednesday afternoon.

The meeting's outcome will influence the mortgage bond market which, in turn, will change current mortgage rates for consumers nationwide.

If you're shopping for a home, then, or about to start a refinance, consider yourself alerted. 30-year rates are hovering near the lowest in 3 years; and, rates for FHA mortgages and VA loans are even lower.

Once the Fed adjourns, rates will look a lot different. The thing is, though, analysts don't know whether rates will be higher or lower.

If you're nervous that rates will rise, consider locking in today.

Click to see today's rates (Oct 22nd, 2016)

The Fed Does Not Control Mortgage Rates

The Federal Open Market Committee (FOMC) meets this week and your future mortgage rate is at stake.

The FOMC is a rotating, 12-person sub-committee within the Federal Reserve, headed by Federal Reserve Chairwoman Janet Yellen.

The FOMC meets eight times annually on a pre-determined schedule, and on an emergency basis, when needed, as was required between 2008-2011 when the U.S. economy was staving off depression; and in 2013 when the U.S. government failed to raise its debt limit.

The FOMC's most well-known role worldwide is as keeper of the Fed Funds Rate.

The Fed Funds Rate is the prescribed rate at which banks lend money to each other on an overnight basis.

When the Fed Funds Rate is low, the Fed is attempting to promote economic growth. This is because the Fed Funds Rate is correlated to Prime Rate, which is the basis of most bank lending including many business loans and consumer credit cards.

For the Federal Reserve, manipulating the Fed Funds Rate is one way to manage its dual-charter of fostering maximum employment and maintaining stable prices.

The Fed's zero-interest rate policy has helped to create jobs -- more than 13 million since 2010 -- and, for now, price pressures within the economy remain low.

Some would say, then that the Fed is managing its dual-charter ably.

However, a low Fed Funds Rate creates wage pressure and promotes risk-taking, both of which can quickly lead to inflation (i.e. rising prices). Plus, wage pressure may be mounting with the unemployment rate reaching 5 percent nationwide.

For this reason, the Federal Reserve ended its zero-interest rate policy in December 2015, raising rates by 25 basis points (0.25%) for the first time in more than a decade.

However, the Fed move did not lead to an increase in consumer mortgage rates. On the contrary, mortgage rates have dropped more than 60 basis points (0.60%) since the Fed's late-2015 move.

This is because U.S. mortgage rates aren't set or established by the Federal Reserve or any of its members. Rather, mortgage rates are determined by the price of mortgage-backed securities (MBS), a security sold via Wall Street.

The Federal Reserve can affect today's mortgage rates, but it cannot set them.

Click to see today's rates (Oct 22nd, 2016)

The Fed Funds Rate & Mortgage Interest Rates

It's a common belief that the Federal Reserve "makes" consumer mortgage rates. It doesn't. The Fed doesn't make mortgage rates. Mortgage rates are made on Wall Street.

The Federal Reserve has no direct connection to U.S. mortgage rates whatsoever.

Here's proof: Over the last two decades, the Fed Funds Rate and the average 30-year fixed rate mortgage rate have differed by as much as 5.25%, and by as little as 0.50%.

If the Fed Funds Rate were truly linked to U.S. mortgage rates, the difference between the two rates would be linear or logarithmic -- not jagged.

That said, the Fed does exert an influence on today's mortgage rates.

After its scheduled meetings, the FOMC issues a press release to the public which highlights the group's economic opinions and consensus.

When the FOMC's post-meeting press release is generally "positive" on the U.S. economy, mortgage rates tend to rise. Conversely, when the Fed is generally negative with its outlook, mortgage rates tend to fall.

Lately, the Fed has shown a mix of positive and negative sentiment.

The group has acknowledged that the U.S. economy is improving, but that growth obstacles remain. It has also said that inflation rates remain stubbornly low, which is a concern as well.

The Federal Reserve's official statement will be released at 2:00 PM ET Wednesday.

Expect mortgage rates to be volatile and difficult to lock. It may be prudent to shop for a mortgage before the Fed adjourns rather than after.

Click to see today's rates (Oct 22nd, 2016)

What The Fed Says Can Change Mortgage Rates

The Fed does more than just set the Fed Funds Rate. It also gives economic guidance to markets.

For rate shoppers, one of the key messages for which to listen is the one the Fed spreads on inflation. Inflation is the enemy of mortgage bonds and, in general, when inflation pressures are growing, mortgage rates are rising.

The link between inflation rates and mortgage rates is direct, as homeowners in the early-1980s experienced.

High inflation rates at the time led to the highest mortgage rates ever. 30-year mortgage rates went for over 17 percent (as an entire generation of borrowers will remind you); and 15-year loans weren't much better.

Inflation is an economic term describing the loss of purchasing power. When inflation is present within an economy, more of the same currency is required to purchase the same number of goods.

We experience inflation at the grocery store.

A gallon of milk used to cost $2. Today, it costs $3. More money is required to purchase the same amount of milk because each dollar holds less value.

Meanwhile, mortgage rates are based on the price of mortgage-backed securities (MBS) and mortgage-backed securities are U.S. dollar-denominated. This means that a devaluation in the U.S. dollar will result in the devaluation of U.S. mortgage-backed securities as well.

When inflation is present in the economy, then, the value of a mortgage bond drops, which leads to higher mortgage rates.

This is why the Fed's comments on inflation are closely watched by Wall Street. The more inflationary pressures the Fed fingers in the economy, the more likely it is that mortgage rates will rise.

Inflation is currently well below the Fed's 2 percent per year target.

What Are Today's Mortgage Rates?

The Federal Reserve adjourns from its first scheduled meeting of the year Wednesday afternoon. Current mortgage pricing may change within minutes.

Take a look at today's real mortgage rates now. Your social security number is not required to get started, and all quotes come with instant access to your live credit scores.

Click to see today's rates (Oct 22nd, 2016)

The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.

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2016 Conforming, FHA, & VA Loan Limits

Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)