In recent months we have seen the Fed "cut rates" on three occasions.  The first cut was a 50 basis point cut followed by a second 50 basis point cut and last week an additional 25 basis point cut however rates have not changed in step with the cuts.  Mortgage interest rates in the past two months have improved slightly but not to the degree that most consumers would think based upon the headlines. 

Contrary to popular myth, the Fed (more properly, the Federal Reserve) does not control mortgage rates.  In fact, their most well-known policy tool -- the Federal Funds rate -- is the overnight interest rate which banks charge each other when a bank needs to borrow money to meet end-of-day reserve requirements. Simply, those rules say that a bank must have so much cash on hand when the books close at the end of the day, and those funds can be borrowed from another bank at this interest rate. You should know that the Fed merely "suggests" what that rate should be, which is why it's called a "target" rate; the actual rate is negotiated between the borrower bank and the lender bank.

A good way to keep a handle on the Fed is to remember that the Fed Funds rate is the shortest of short-term rates -- literally, an overnight loan -- and a fixed-rate mortgage is all the way at the other end of the scale, a loan that lasts as long as 30 years.

From Fed Funds moves, there's a complicated discussion of monetary policy about how Fed moves affect certain deposit and loan markets and inflationary expectations. We'll leave that for another article.

The end result is that the Fed raises or lowers interest rates to help address increases or decreases in economic activity. Lower rates can help banks to make certain kinds of loans less expensively, especially for business and certain kinds of consumer lending, and that can help to generate greater economic growth. Higher rates can cool demand, helping to keep inflationary pressures from forming.  In some ways, expectations of what the Fed might do, can be more important than what the Fed actually does, as their actions or inactions can help to confirm or deny what investors believe.

You may also have noticed that sometimes the Fed cuts interest rates -- and fixed mortgage rates actually rise as a result. Why? If the Fed is taking steps to address economic weakness by lowering rates, that likely means that a return to faster growth -- and possible higher inflation, as well -- is coming sooner, rather than later.  So what moves mortgage rates? Supply. Demand. Competition for money. Inflation. The Economy. Expectations. And you, of course. We hope that this helps you understand a little better how the whole thing works.

The purpose of this newsletter is to stimulate thought for our clients and those professionals we network with. One should consult with a qualified mortgage  professional prior to implementing any mortgage planning strategies. 

If you are a financial planning, insurance  or real estate professional, a CPA or legal professional receiving this newsletter or know of one, please contact our office to introduce yourself and your services to us.  We are always seeking to grow our referral network and expose professional services to our client base.