Mortgage Q&A: “Does the Fed control mortgage rates?”
With all the recent hubbub concerning mortgage rates, and the Fed, you might be wondering how it all works.
Does the Federal Reserve decide what the interest rate on your 30-year fixed mortgage is going to be?
Or is it dictated by the open market, similar to other products and services, which are supply/demand driven.
Before getting into the details, we can start by saying the Fed doesn’t directly set mortgage rates for consumers. But it’s a little more complicated than that.
The Federal Reserve Plays a Role in the Direction of Mortgage Rates
As noted, the Federal Reserve doesn’t set mortgage rates. They don’t say, “Hey, the housing market is too hot, we’re increasing your rates.” Or vice versa.
This isn’t why the 30-year fixed started 2022 at around 3.25%, and is now closer to 5.5%.
However, the Fed does get together eight times per year to discuss the state of economy and what might need to be done to satisfy their “dual mandate.”
That so-called “dual mandate” sets out to accomplish two goals: price stability and maximum sustainable employment.
Those are the only things the Federal Reserve cares about. What happens as a result of achieving those goals is indirect at best.
For example, if they determine that prices are rising too fast, they’ll increase the overnight lending rate, known as the federal funds rate.
This is the interest rate financial institutions charge one another when lending excess reserves.
When the Fed raises this target interest rate, commercial banks increase their rates as well.
So things do happen when the Fed speaks, but it’s not always clear and obvious, or what you might expect.
What Does the Fed Decision Mean for Mortgage Rates?
The Fed Open Market Committee (FOMC) is holding its closed-door, two-day meeting beginning today.
While we won’t know all the details until the meeting concludes and they release their statement, it’s widely expected that they’ll raise the fed funds rate another .50%.
This would be the second such increase since 2018, thereby increasing the federal funds rate to a target range of .75% to 1%.
If and when this happens, which is basically a sure thing, banks will begin charging each other more when they need to borrow from one another.
And commercial banks will increase the prime rate by the same amount, from its current rate of 3.50% to 4%.
As a result, anything tied to prime (such as credit cards and HELOCs) will go up by that amount.
However, and this is the biggie, mortgage rates will not increase by .50% if the Fed increases its borrowing rate by .50%.
In other words, if the 30-year fixed is currently priced at 5.5%, it’s not going to automatically increase to 6% when the Fed releases its statement tomorrow.
Simply put, the Fed doesn’t set mortgage rates. But as noted, what they do can have an impact.
In fact, mortgage rates have already been creeping higher ahead of the Fed meeting because everyone thinks they know what the Fed is going to say.
Because of that, the hope is any impact post-statement will be muted or even potentially good news for mortgage rates.
Why? Because details might already be “baked in,” similar to how bad news sometimes causes individual stocks or the overall market to rise.
The Fed Has Mattered More to Mortgage Rates Lately Because of Quantitative Easing (QE)
While the Fed does play a part in which direction mortgage rates go, they’ve held a more active role lately than during most times in history.
It all has to do with their mortgage-backed security (MBS) buying spree that took place over the past near-decade, known as Quantitative Easing (QE).
In short, they purchased billions in MBS as a means to lower mortgage rates. A big buyer increases demand, thereby increasing the price and lowering the yield (aka interest rate).
The main focus of the Fed’s meeting tomorrow, at least with regard to mortgage rates, is the end of QE, which is known as “Policy Normalization,” or Quantitative Tightening (QT).
This is the process of shrinking their balance sheet by allowing these MBS to runoff (instead of reinvesting proceeds) or even be sold.
Since the Fed mentioned this concept in early 2022, mortgage rates have been on a tear, nearly doubling from their sub-3% levels.
Mortgage lenders will be keeping a close eye on what the Fed has to say about this process, in terms of how quickly they plan to “normalize.”
And how they’ll go about it, e.g. by simply not reinvesting MBS proceeds, or by outright selling them.
They won’t really bat an eye regarding the increase in the fed funds rate, as that has already been telegraphed for a while, and is already baked in.
So when the Fed increases its rate by 50 basis points tomorrow (.50%), don’t say the Fed raised mortgage rates. Or that 30-year fixed mortgage rates are now 6%.
It could technically happen, but not because the Fed did it. Only because the market reacted to the statement in a negative way, by increasing rates.
The opposite could also happen if the Fed takes a softer-than-expected stance to their balance sheet normalization.
Mortgage rates could actually fall after the Fed releases its statement, even though the Fed raised rates.
(photo: Rafael Saldaña)