Thanks for visiting The Mortgage Reports. To stay absolutely current on mortgage markets and important guideline changes, be sure to take my free daily email alerts.

Recapping the FOMC statement from January 27, 2010 and what it means for mortgage rates.

The Federal Open Market Committee adjourns from its two-day meeting this afternoon.  The voting members are widely expected to lower the Fed Funds Rate by a half-percent to 0.500 percent, the lowest Fed Funds Rate in recorded history.

Mortgage rates should rise in response.

This is a counter-intuitive relationship for most people because when they hear the Fed is "lowering rates", they instinctively think "mortgage rates".  That's not the case.

The Fed Funds Rate has no direct impact on mortgage rates.

The Fed Funds Rate is an interest rate usually reserved for loans between banks, made at the close of the business one day and repaid at the start of busines the next day.  This is why the Fed Funds Rate is often called an "overnight rate"  -- the money is literally borrowed overnight.

By contrast, mortgage money is typically lent for 30 years -- 10,957 overnight rates strung together.  It's a completely different risk class for banks.

That said, the Fed Funds Rate does have an indirect impact on mortgage rates because cuts to the Fed Funds Rate are meant to spur business and consumer spending, propelling the economy forward.  Mortgage rates come into play because there's always the danger that the economy gets propelled too far forward and headlong into inflation.

We call this the Fool in the Shower Theory.  It says that the Fed is like a guy starting up the shower and turning the knob all the way to "H".  Once the water heats up, as we've all experienced, it heats up quickly and the guy gets burned.

So, if Wall Street thinks the Fed is over-heating the economy long-term with its rate cuts today, expect mortgage rates should increase over the next 3 days.  This is what's happened after each of the last 10 rate cuts.

And, ironically, if Wall Street thinks the Fed's not adding enough stimulus, mortgage rates should rise then, too.  This is because Wall Street will think the fed is not doing enough  to help the economy and a fear of depression may settle it.  This would draw investor dollars away from all security types and into U.S. treasuries.  Sell-side pressure on mortgage-backed bonds is bad for mortgage rates.

In other words, unless the Federal Reserve announces a plan to purchase mortgage-backed bonds today, it's a can't win situation for mortgage rate shoppers.  Get in and get locked prior to 2:15 P.M. ET.

While former Fed Chairman Alan Greenspan goes to the press in defense of his reputation, the Wall Street Journal's Greg Ip gets practical, talking about the Federal Reserve's options as the current credit crunch deepens.

Cut the Fed Funds Rate?  Well, that benchmark rate is down 3 percent since September 2007 and now sits at 2.250%.  That hasn't seemed to right the ship, though, because we're all still talking about recession.

Today, just in time for the Fed's upcoming meeting, Ip's piece in the Wall Street Journal gives an interesting look at some oft-ignored tools in the Federal Reserve's toolbox.

The Fed's stated mission is to provide stability and flexibility to the U.S. monetary system and there are a several unusual-but-worthy tactics to move towards that goal:

Read the rest of this entry »

The FOMC is meeting today, but we have to wonder if they already achieved their goal of slowing down the economy just six weeks ago with a psychological play.

Prior to the August get-together, the FOMC had raised the Fed Funds Rate from 1.000% to 5.250% over a period of two years and a few months.

With each successive increase came a public statement that explained why the FOMC voted for the increase, something akin to "we want to make sure that prices don't run up out of control."

This is also known as inflation.

At their last meeting, though, the Fed decided to stay put.  No increase at all.  And this happened even as the economy was showing zero signs of slowing down.

Regardless, markets applauded the Fed Pause and thus began the long, slow conversion to the belief that FOMC is now done raising the FFR altogether. There is a 94% probability that the FFR would hold at 5.25% this afternoon, according to the Fed Funds Rate futures market.

Meanwhile, after the August meeting, economic indicators showed signs that the economy actually was cooling off:

• Oil prices came down
• CPI came down
• PPI came down
• Housing markets slowed

Looking back at the FOMC meeting in August, there are two well-debated points about what has happened since:

1. Prices and costs have dropped because markets are now expecting a general economic slowdown moving forward
2. Despite the inflationary data, the Fed saw a pattern that said inflation was no longer a threat

Most pundits are in one camp or the other.  I'm in neither.

I see it as the Fed elected to hold pat at 5.250% as a last-ditch effort to slow the inflation stampede.  This was a pure psychological play against the markets.  The FOMC was simply out of options.

See, the Fed kept telling us that the economy was spiraling out of control.  Hence, the hikes in the Fed Funds Rate.

But with each increase, markets took that future expectation and then traded on it.

In effect, inflation became a self-fulfilling prophecy.

So, at the August 8 meeting, the Fed may have recognized how their rate hikes were actually contributing to inflation -- traders were actually pushing markets forward in the form of futures, causing higher prices.

Remember how pricey copper was several months back, and other commodities, too?

Because the economy was not slowing down the "traditional way" (i.e. with hikes to the FFR), the FOMC decided to slow it down with a different tactic.

Mind games.

"If the Fed didn't raise rates," markets wondered, "they must know something.  Maybe we should stop playing for inflation."

And so they did.  And prices dropped.  And so did a bunch of key inflation indicators.

The economy was running at uncomfortable inflation levels August 8, but it is entirely possible that -- after 17 consecutive rate hikes -- that the Fed realized the only way to slow things down was to fake the markets into slowing themselves down.

It's a psychological play, but absolutely effective.  And today, expect another pause.

A look at the National Savings Rate shows that Americans are saving at a rate of -1.50%.  As a nation, we're spending more than we earn. 

By a lot. 

This is one of the reasons why the economy won't seem to slow down -- Americans just keep spending and spending.

Combine that with a few other news tidbits from the Fed, and the picture on the future of the Fed Funds Rate gets really fuzzy.

1. St. Louis Fed President Poole said that he sees a 50% chance of another rate hike on August 8.  Considering that the markets are pricing in an expectation of about 40%, that means that either the markets are wrong, or Poole is all wet.  Is that the worst pun ever?
2. San Francisco Fed President Yellen said that the Fed "is close to the end of the road" with respect to rate hikes.
3. New Treasury Secretary Hank Paulson was on CNBC and he said that he has been eating breakfast with Fed Chairman Bernanke once weekly and he sees no recession on the horizon.

Data-dependant or not, the Fed voting members are people, and are just as susceptible to emotional decisions as the rest of us. 

I am not saying that the Fed is done with rate hikes, but it sure sounds like a lot of people are throwing in the towel in advance of the FOMC meeting next week.

This morning, Chicago Federal Reserve Board President  Michael Moskow gave a spirited talk to members of Jobs For Youth, a Chicago-based community organization that helps young adults train to enter the workforce with the necessary skills.

I was among the 100 people or so crammed into a breakfast/conference room, but as you can tell from the photo, I had a pretty good seat.  It's too bad my Treo 650 can't take higher mega-pixel photos -- I swear that Dr. Moskow is less grainy in real life.

The speech was an enjoyable one.  Dr. Moskow talked about:

• The basement of the Chicago Federal Reserve Bank ("that holds $8-9 billion dollars")
• The number of bills that circulate through the Chicago Fed that are unfit to re-enter people's wallets ("about one-third")
• How rising oil prices slow down the economy ("by taking away money to be spent elsewhere -- a little like a tax").

Then there was a Q & A session.

Now, if you know me well, you know that I have loads of questions I would have loved to hear the 12-year FOMC veteran answer. 

• Do the voting members make up their minds before showing up at the meeting? 
• Does everyone just vote with the Chairman so that markets don't freak out about dissension? 
• Do you really think that the FOMC statements clear to average Americans?

Instead, the question that came out of my mouth was this: 

"Why does the Fed only raise or lower rates in 25 basis point increments?  Why not 10 basis points?  Or six?"

There was brief silence in the room and some muffled laughter (probably at me being an idiot).  Crickets.

I think I stumped Dr. Michael Moskow.

After the pause (and without answering the question), Dr. Moskow told a funny story about the "measured pace" verbiage that became so closely watched the past two years. 

When the Fed started raising rates from the 1.00% level June 30, 2004, it raised the Fed Funds Rate by 0.25% and said that it would continue to raise rates at a "measured pace" as it deemed necessary.

At the next meeting, the Fed raised rates by 0.25% and again included the "measured pace" verbiage.

Then, at the next meeting, the Fed raised rates by 0.25% and so the markets interpreted "measured pace" to actually mean "a 25 basis point increase".  This is a case of the markets dictating to the Fed how to communicate to them. 

It's funny in an ironic way.

At this point, I think Moskow realized that he not only didn't answer my question, he didn't even allude to it.  So, he said, "Never say never."

So the FOMC meets again August 8, 2006 and the voting FOMC members will sit in a room, discussing what do to about the Fed Funds Rate.  Raising it by 25 basis points is too high some will argue.  Not raising it at all will be too little, others will say.

Not Moskow.  He's going to vote for a 16 basis point increase now that the idea's been planted in his brain -- never say never, after all.