Why You’ll Want To Lock Your Mortgage Rate Before The Fed Adjourns April 29, 2009

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The Federal Reserve meets next week for a policy-setting meeting. 

It’s one of 8 scheduled Fed meetings this year in which the Federal Open Market Committee votes on whether to raise, lower, or leave unchanged the Fed Funds Rate. The Fed Funds Rate is the rate at which banks lend money to each other overnight, often to be repaid the following morning.

If the idea of banks borrowing money just for an overnight period sounds like jive to you, you're not alone. Banks have do it, though, because banking regulators make lenders keep a certain percentage of "cash reserves" on hand at all times. When bank cash levels fall, they borrow the funds from another Federal Reserve member bank in the interim.

Banks can also borrow from the Federal Reserve directly, often at a slightly higher rate.

So, because the Fed Funds Rate is directly tied to bank interest payments, it exerts a palpable influence on the economy.  By changing the borrowing costs for banks, borrowing costs change for businesses and consumers, too.  Prime Rate, for example, is the basis of most business and consumer loans and is expressed as:

When the Fed Funds Rate is lowered, therefore, “cheap money” propels the economy forward.  When the Fed Funds Rate is raised, by contrast, more costly borrowing often slows the economy down.

Changes to the Fed Funds Rate do not directly correlate to changes in mortgage rates, though.  One way to understand this is to look at the Fed Funds Rate as an "overnight rate" where mortgage money is often a 30 year rate. 

30 years is 10,957 overnight rates strung together -- a completely different risk class.

The Fed Funds Rate's macroeconomic implications, in part, led to the creation of the Fed Funds Futures market.  Traded on the Chicago Board of Trade, Fed Funds Futures options contracts lets investors "bet" on what the Federal Reserve will do to the Fed Funds Rate at the next Fed meeting.

Based on data compiled by the Federal Reserve Bank of Cleveland, here's the market's expectation for the April 28-29, 2009 meeting:

• 97 percent expectation that the Fed Funds Rate will hold at 0.000 to 0.250%
• 3 percent expectationthat the Fed Funds Rate will raise to 0.750%.

There is zero expectation for a 0.500% Fed Funds Rate.

Because Wall Street is nearly unanimous in its Fed Funds Rate prediction, expect the market’s FOMC focus to be on what the Fed says next week rather than what it does. 

If Bernanke & Co. express concerns about long-term inflation and the need to contain growth, mortgage rates should rise.  On the other hand, if the Fed expects growth to be within a tolerable range, mortgage rates should idle. 

In other words, if you're shopping for mortgages right now, there’s little reason to wait for the Fed's next move before making your “Float or Lock” decision.  In a worst-case scenario, mortgage rates rise.  In a best-case scenario, they idle.

The Fed’s two-day meeting adjourns Tuesday, April 29 at 2:15 PM ET.

(Post adapted with permission from Bring the Blog)