Why Fed Rate Cuts Do Not Equal Lower Mortgage Rates
Posted: February 19th, 2008 @ 6:12pm
Source: The Ethridge Team Times- February 2008
So the Federal Reserve cut rates again! Many people are calling their mortgage lender to purchase or re-finance their home and are expecting a lower interest rate. These people are puzzled as to why mortgage rates have not moves lower during the recent 5 Fed rate cuts. In fact, mortgage rates are now higher than they were before the Fed began cutting rates in January. This is difficult to explain to many people who have watched a 2.5% reduction by the Fed with no benefit in mortgage rates.
Is a Fed rate cut really good news for mortgage rates? The facts may be surprising. The Fed can only control the Discount Rate and the Fed Funds Rate. This is very different from mortgage rates. A mortgage rate can be in effect for 30- years, whereas a rate that is set by the Fed can change from one day to another.
Another common mistake is in thinking that 30- year Treasury bonds or 10- year Treasury notes are directly related to mortgage rates. Those are government securities that are backed by the full faith and credit of the U.S. government and have no direct effect on mortgage rates.
So what are mortgage rates based on? As it turns out the answer is mortgage-backed bonds known as Mortgage Backed Securities (MBS). Bonds issued by Fannie Mae and Freddie Mac (MBS) and the trading performance of those bonds will determine the direction of mortgage rates. Finding the catalyst that causes mortgage bonds to move will give you the keys to finding out what makes mortgage rates rise or fall.
Over the past several years, one catalyst that seems to be working in the opposite direction of MBS prices is the NASDAQ and broader stock market. As bond prices rise, interest rates fall. As bond prices fall, interest rates rise. The NASDAQ Composite Index and the Fannie are almost mirror images of each other. The consistency of this behavior is astounding. As the NASDAQ moves higher, bond prices move lower causing interest rates to rise. As the NASDAQ declines, mortgage bonds benefit, causing mortgage rates to fall. Basically, it appears that since Fed rate cuts act to stimulate the NASDAQ, they have a negative effect on mortgage rates.
The bottom line is that it appears mortgage rates will get better if the NASDAQ sells off and will get worse if
the NASDAQ rallies. So it is not necessarily what the Fed does that affects mortgage rates, its how the NASDAQ and broader stock market interprets the Fed’s action that will ultimately influence the direction of mortgage rates. This is because money managers and mutual fund companies typically keep funds in either stocks or bonds with very little cash. If stocks are in favor, money is pulled from bonds, causing bond prices to drop and interest rates to rise. When stocks are being sold off, the money is then parked into the bonds, which improves bond prices and causes interest rates to decline.
