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How Mortgage Interest Rates React to Federal Reserve Meetings

Will the Federal Reserve Reduce Interest Rates?

The Federal Reserve does not control mortgage rates. However, it has had a massive influence on them during the epidemic.

Over the last year, the fed has purchased consumer mortgages worth billions of dollars to keep rates low during COVID. This, along with an overall low-interest-rate strategy, contributed to mortgage rates remaining near record lows for the majority of 2020 and the beginning of 2021.

However, rates are beginning to climb. Experts think the fed will do nothing to stop them.

As the economy improves, interest rates will inevitably increase, which is bad news for debtors. As COVID becomes less relevant, the fed will ultimately withdraw its mortgage rate actions, and the two will resume a more “normal” relationship.

What Takes Place at Federal Reserve Meetings?

Typically, the Federal Open Market Committee (FOMC) meets once every six weeks to review interest rate policy.

The FOMC is a 12-member rotating subcommittee of the Federal Reserve, led by Chairman of the Federal Reserve Jerome Powell.

The FOMC meets eight times per year on a predetermined schedule and an emergency basis when necessary, such as between 2008 and 2011 when the U.S. economy was struggling to avoid a recession and in 2013 when the U.S. government failed to extend its debt ceiling.

The Federal Open Market Committee’s (FOMC’s) most well-known function internationally is as the guardian of the federal funds rate. However, how precisely does the federal funds rate affect your finances?

Typically, the Federal Reserve Does Not Regulate Mortgage Rates

The assumption that the Federal Reserve “makes” consumer mortgage rates is widespread. It does not. Wall Street determines mortgage interest rates.

Here’s the evidence: over the past two decades, the average 30-year fixed mortgage rate and the fed funds rate have varied by more than five percentage points and as little as 0.50%.

If the fed funds rate were related to mortgage rates in the United States, the gap between the two rates would be linear, logarithmic, and not jagged.

However, the fed does impact mortgage rates today.

The FOMC produces a press statement highlighting the group’s economic thoughts and consensus following each of its regular sessions.

Mortgage rates tend to increase when the FOMC’s post-meeting press release is generally “positive” on the U.S. economy. In contrast, mortgage rates tend to decline when the fed’s forecast is typically negative.

Due to COVID, economic news has been mostly bad during the past year. Consequently, interest rates, particularly mortgage rates, have remained near all-time lows.

However, if an increasing number of Americans receive vaccinations and the economy begins to recover, these patterns will reverse, and mortgage rates are expected to climb.

How the Fed Has Recently Affected Mortgage Rates

Typically, the fed’s influence on mortgage rates is, at best indirect (as will be shown in further detail below).

However, the Federal Reserve does have one direct influence on mortgage rates.

This is accomplished through “quantitative easing” (QE).

QE occurs when the fed injects money into the U.S. economy to maintain low-interest rates and, by extension, to keep consumers borrowing and dollars flowing.

Consider what the fed did during the onset of the COVID-19 epidemic. Since March 2020, it has acquired consumer mortgages worth billions of dollars on the secondary market.

More liquidity on the secondary market results in reduced interest rates for borrowers. Due to the fed’s infusion of cash, mortgage rates reached and remained at record lows for nearly nine months.

The standard refrain from mortgage specialists, “the Fed does not influence mortgage rates,” remains accurate. The Fed Funds rate is not directly linked to mortgage interest rates.

However, this statement now has a giant asterisk, since it has become evident that the Federal Reserve can significantly affect interest rates when necessary.

What Is the Significance of a Federal Reserve Interest Rate Cut?

The fed funds rate is the rate at which banks can lend money to one another overnight.

When the fed funds rate is low, the fed seeks to stimulate economic expansion. This is because the fate of fed money is associated with the Prime Rate, which is the basis for most bank lending, including many corporate loans and consumer credit cards.

The Federal Reserve manipulates the fed funds rate as part of its twin mandate to promote maximum employment and preserve price stability.

However, a low fed funds rate produces wage pressure and encourages risk-taking, which can rapidly lead to rapid inflation (rising prices).

In December 2015, the Federal Reserve terminated its zero-interest-rate policy, hiking rates by 25 basis points (0.25%) for the first time in more than a decade.

However, the fed’s action did not result in a rise in mortgage rates for consumers. After the fed’s late 2015 action, mortgage rates declined by more than 50 basis points (0.50%).

This is because the Federal Reserve or any of its members do not determine or establish mortgage rates in the United States. Mortgage rates are now decided by the price of mortgage-backed securities (MBS), a Wall Street-traded instrument.

The Federal Reserve can influence current mortgage interest rates, but it cannot establish them.

How Federal Reserve Announcements Affect Mortgage Rates

The Federal Reserve does more than only determine the fed funds rate. It also provides markets with economic direction.

One of the most critical signals for rate consumers to hear is what the fed has to say about inflation. Inflation is the enemy of mortgage bonds, and mortgage rates tend to rise when inflationary pressures increase.

Homeowners experienced the direct relationship between inflation and mortgage rates in the early 1980s.

At the time, significant inflation led to the highest mortgage rates ever. A whole generation of borrowers will recall that 30-year mortgage rates exceeded 17%, and 15-year loans were not much better.

The fed does not regulate mortgage rates, yet there is a clear correlation between inflation and mortgage rates.

Inflation is a phrase used in economics to describe the decline in buying power. When an economy is experiencing inflation, more of the same currency is required to acquire the same quantity of products.

We encounter inflation in the supermarket.

Historically, a gallon of milk costs $2. Currently, it costs $3. Because each dollar is worth less, that means more money is necessary to purchase the same quantity of milk

Meanwhile, mortgage rates are determined by the price of mortgage-backed securities (MBS), denominated in U.S. dollars. This means that a decline in the value of the U.S. dollar will also result in a decline in the value of U.S. mortgage-backed securities.

Therefore, when inflation is present in the economy, the value of mortgage bonds declines, resulting in higher mortgage rates.

Wall Street, therefore carefully follows the fed’s views on inflation. The more the fed’s inflationary influence on the economy, the greater the likelihood that mortgage rates will rise.

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