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 mortgage rates tomorrow. Sorry.”
This isn’t why the 30-year fixed started the year 2022 at around 3.25%, and is now closer to 7% today.
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 (inflation), they’ll increase their overnight lending rate, known as the federal funds rate.
This is the interest rate financial institutions charge one another when lending their excess reserves. Theoretically, higher rates mean less lending, and less money sloshing around the economy.
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.
Perhaps more importantly, their actions are usually known in advance, so lenders often begin raising or lowering rates well beforehand.
What Does the Fed Decision Mean for Mortgage Rates?
The Fed Open Market Committee (FOMC) holds a closed-door, two-day meeting eight times a year.
While we don’t know all the details until the meeting concludes and they release their corresponding statement, it’s typically fairly telegraphed.
So if they’re expected to raise the fed funds rate another .50%, it’s generally baked in to mortgage rates already.
Or if they plan to cut rates, you might see lenders repricing their rates in the weeks preceding the meeting.
Since early 2022, they’ve increased the federal funds rate 11 times, from about zero to a target range of 5.25% to 5.50%.
When they raise this key rate, banks charge each other more when they need to borrow from one another.
And commercial banks will increase the prime rate by the same amount. So a 0.50% move in the fed funds rate results in a 0.50% move in the prime rate.
As a result, anything tied directly to prime (such as credit cards and HELOCs) will go up by that exact amount as well.
However, and this is the biggie, mortgage rates will not increase by 0.50% if the Fed increases its borrowing rate by 0.50%.
In other words, if the 30-year fixed is currently priced at 7%, it’s not going to automatically increase to 7.5% when the Fed releases its statement saying it increased the fed funds rate by 0.50%.
What the Fed Says or Does Can Impact Mortgage Rates Over Time
So we know the Fed doesn’t set mortgage rates. But as noted, what they do can have an impact, though it’s typically over a longer time horizon.
Fed rate hikes/cuts are more of a short-term event, while mortgage rates are long-term loans, often offered for 30 years.
This is why they correlate better with the 10-year bond yield, as mortgages are often held for about a decade before being refinanced or the home sold.
As such, mortgage rate tracking is better accomplished by looking at the 10-year yield vs. the federal funds rate.
But if there’s a trend over time, as there has been lately with hike after hike, both the federal funds rate and mortgage rates can move higher in tandem as the years goes by.
For the record, sometimes mortgage rates creep higher (or lower) ahead of the Fed meeting because everyone thinks they know what the Fed is going to say.
But it doesn’t always go as expected. Sometimes the impact post-statement will be muted or even potentially good news for mortgage rates, even if the Fed raises 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 (indirectly) 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 trillions 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).
When the Fed’s meeting centers on the end of QE, which is known as “Policy Normalization,” or Quantitative Tightening (QT), mortgage rates may react more than usual.
This is the process of shrinking their balance sheet by allowing these MBS to run off (via refinance or home sale) or even be sold, instead of continually reinvesting the proceeds.
Since the Fed mentioned this concept in early 2022, mortgage rates have been on a tear, nearly doubling from their sub-3% levels. That’s been more of the driver than their rate hikes.
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 the next time the Fed increases its rate by 50 basis points (.50%), don’t say the Fed raised mortgage rates. Or that 30-year fixed mortgage rates are now 7.5%.
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 be true if the Fed takes a softer-than-expected stance to their balance sheet normalization. Or if they cut their own rate. But mortgage rates would not fall by the same amount of the rate cut.
By the way, mortgage rates could actually fall after the Fed releases its statement, even if the Fed raised rates.
(photo: Rafael Saldaña)
