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In a surprise move yesterday, the Federal Reserve cut the benchmark Fed Funds Rate by three-quarters of a percent.  Mortgage rates fell only slightly as the surprise quickly wore off.

To understand how the element of surprise works in mortgage markets, think about a Jack-in-the-Box. 

Everybody knows that the clown is coming, they just don't know how many turns of the crank it will take.  When it pops out, there's an immediate shock.  Then it's back to business.

This simplified analogy is similar to what happened yesterday, post-rate cut.  It's why many people that expected rates to fall further were dissappointed.

The bigger reason why mortgage rates don't fall when the Federal Reserve cuts the Fed Funds Rate is because Federal Reserve does not control mortgage rates; it controls the Fed Funds Rate. 

Mortgage rates are based on the prices of 30-year instruments called mortgage bonds; the Fed Funds Rate is an overnight interest rate.  Both, however, tend to fall during periods of economic weakness. 

• The Fed Funds Rate falls to stimulate the economy
• Mortgage rates fall because inflation is less threatening

Prior to yesterday's surprise cut, market expectations for the FOMC's two-day meeting were:

• 42% expected a 0.500% drop, representing moderate weakness in the economy 
• 38% expected a 0.750% drop, representing strong weakness in the economy 
• 18% expected a 1.000% drop, representing very strong weakness in the economy

So, any mortgage rate movement from yesterday was the people in the 0.500% camp moving their portfolios down to 0.750%, and the people in the 1.000% camp moving their portfolios up.

Remember: mortgage markets are "open" every day whereas the Fed meets just eight times annually.  This gives the markets a ton of time to intrepret news, listen to Fed speakers, and generally prepare for the next Federal Reserve meeting. 

And many were already prepared -- even if it came a few days early.

The big winners yesterday were people with home equity lines of credit, and those that carry credit card balances.  Effective January 22, 2008, your borrowing rates just fell 0.750%.

Prime Rate is now 6.500%.

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Dan Green is an active loan officer. Email or call 513-443-2020. Dan is on Twitter at @mortgagereports.