Mortgage FAQ: “Does the Fed control mortgage rates?”
With all the recent hype surrounding mortgage rates and the Federal Reserve, you’re probably wondering how it all works.
Does the Fed decide the interest rate on 30-year fixed mortgages?
Or is it dictated by the open market, similar to other products and services that depend on supply and demand?
Before going into details, we can start by saying The Federal Reserve does not set mortgage interest rates directly For consumers. But it’s a little more complicated than that.
The Federal Reserve plays a role in guiding mortgage rates
As mentioned, the Federal Reserve does not set mortgage rates. They’re not saying, “Hey, the housing market is so hot, we’re going to increase the interest rates on your mortgage tomorrow. Sorry.”
That’s not why the 30-year fixed yield started 2022 at around 3.25%, and is now closer to 7% today.
However, the Fed meets eight times a year to discuss the state of the economy and what might need to be done to meet their “dual mandate.”
That’s what’s called “Dual mandate“It aims to achieve two goals: price stability and maximum sustainable employment.
These are the only things the Fed cares about. What happens as a result of achieving those goals is not directly perfect.
For example, if they decide that prices are rising too quickly (inflation), they will increase the overnight lending rate, known as the federal funds rate.
This is the interest rate that financial institutions charge each other when lending their excess reserves. In theory, higher interest rates mean less lending, and less money flowing into the economy.
When the Fed raises its target interest rate, commercial banks increase their rates as well.
So things happen when the Fed speaks, but it’s not always clear and clear, or what you might expect.
Perhaps most importantly, their actions are usually known in advance, so lenders often start raising or lowering interest rates long beforehand.
What does the Fed’s decision mean for mortgage rates?
The Federal Reserve’s Open Market Committee (FOMC) holds a two-day closed-door meeting eight times a year.
Although we don’t know all the details until the meeting is over and they issue their corresponding statement, it is usually fairly telegraphed.
So, if they are expected to raise the federal funds rate by another 0.50%, that will generally be built into mortgage rates already.
Or if they plan to lower interest rates, you may see lenders repricing interest rates in the weeks leading up to the meeting.
Since early 2022, they have increased the federal funds rate 11 times, from around zero to a target range of 5.25% to 5.50%.
When banks raise this key rate, banks charge each other additional fees when they need to borrow from each other.
Commercial banks will increase the base interest rate by the same amount. So a 0.50% move in the federal funds rate results in a 0.50% move in the prime rate.
As a result, anything directly tied to Prime (like credit cards and HELOCs) will go up by that specific amount as well.
However, and this is the big thing, Mortgage interest rates will not rise by 0.50% if the Fed increases the borrowing rate by 0.50%..
In other words, if the 30-year fixed rate is currently 7%, it will not automatically rise to 7.5% when the Fed issues its statement saying it has raised the federal funds rate by 0.50%.
What the Fed says or does can affect mortgage rates over time
So we know that the Fed does not set mortgage interest rates. But as mentioned, what they do can have an impact, although usually over a longer period of time.
Fed rate hike/decrease is a short-term event, while mortgage rates are long-term loans, often offered for 30 years.
This is why it correlates better with the 10-year bond yield, as mortgages are often held for about ten years before refinancing or selling the home.
As such, tracking the mortgage rate is best accomplished by looking at the 10-year yield versus the federal funds rate.
But if there is a trend over time, as has happened recently with rise after rise, both the federal funds rate and mortgage interest rates can move in tandem as the years go by.
For the record, sometimes mortgage interest rates go higher (or lower) before a Fed meeting because everyone thinks they know what the Fed is going to say.
But it doesn’t always go as expected. Sometimes the aftereffect of the statement will be weak or even potentially good news for mortgage interest rates, even if the Fed raises rates.
Why? Because the details may already be “hidden,” similar to how bad news sometimes sends individual stocks or the overall market up.
The Fed has been paying more attention to mortgage rates lately due to quantitative easing (QE).
While the Fed plays a role (indirectly) in the direction mortgage interest rates go, it has played a more active role recently than it has at most times in history.
It’s all about the buying spree of mortgage-backed securities (MBS) that has occurred over the past decade or so, known as quantitative easing (QE).
In short, they bought trillions of dollars of mortgage bonds as a way to lower mortgage rates. A large buyer increases demand, thus increasing the price and lowering the yield (also known as the interest rate).
When the Fed meeting focuses on the end of quantitative easing, which is known as “policy normalization,” or quantitative tightening, mortgage rates may react more than usual.
This is the process of shrinking its balance sheet by letting these mortgage-backed securities go (by refinancing or selling homes) or even selling them, rather than continually reinvesting the proceeds.
Since the Fed mentioned the concept in early 2022, mortgage rates have been on a tear, nearly doubling from their levels below 3%. This has been the driver more than raising interest rates.
Mortgage lenders will be closely watching what the Fed has to say about this process, in regards to how quickly they plan to “normalize.”
How they will do this is, for example, by not reinvesting the proceeds of the MBS, or by selling them outright.
They’re not really going to pay attention to the increase in the federal funds rate, because that’s already been telegraphed for a while, and it’s already been internalized.
So, next time the Fed raises interest rates by 50 basis points (0.50%), don’t say the Fed raised mortgage interest rates. Or that 30-year fixed mortgage rates are now 7.5%.
It is technically possible, but not because the Fed did it. Only because the market reacted to the statement in a negative way, by increasing interest rates.
The opposite may also be true if the Fed takes a softer-than-expected stance toward normalizing its balance sheet. Or if they lower their interest rate. But mortgage interest rates will not fall as much as you lower interest rates.
Incidentally, mortgage rates could actually fall after the Fed releases its statement, even if the Fed raises interest rates.
(picture: Rafael Saldaña)
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