GUEST BLOGGER - RICH BIRA, FIRST CAPITAL MORTGAGE, CHICAGO IL
FED RATE CUTS DO NOT ALWAYS EQUAL LOWER MORTGAGE RATES!
(Rich Bira, our Preferred Lending Partner at First Capital Mortgage, Chicago IL, serving all Chicago Neighborhoods and suburbs, has been handing financing for many of our clients for over eight years. His comments today on the relationship between Federal Reserve Interest Rates and Consumer Mortgage Rates are very enlightening. See contact information for Rich at the end of this post.)
As long as I have been a loan officer, which is over ten years, I have been asked this question - Why?
I am going to try and explain why mortgage rates usually move higher after the Fed lowers the keys interest rates, which if the Fed Fund Rate and the Fed Discount Rate.
First a quick explanation on what these two rates are. To give a simple answer, these two rates are the interest rates the big banks use to loan money to each other over night. Now, the Fed Fund Rate does have a direct impact on credit cards, savings rates and Home Equity loans that are tied to prime. When the Fed Fund rate moves one direction or the other, the prime rate will move in lock step almost immediately the same amount.
Howver, for a 30 year mortgage, this rate is actually tied to the Bonds that are sold by Fannie Mae and Freddie Mac. These are called Mortgage Backed Securities, and go by the technical name of FNMA 30 Yr 5.5 Spot Bond.
Mortgage rates are NOT tied to the 10 Year Treasury Note. Unfortunately the media usually uses this as the bench mark for gauging the movement of interest rates. They usually move in the same direction as the spot bond, but definitely not always.
So, this being said, to truly determine what makes mortgages rates go up or down, we have to pinpoint the catalyst that moves the mortgage bonds. That catalyst would be INFLATION. Inflation is a negative for long term bonds due to the fact that it eats away the value of the bond in the future.
Another catalyst is the stock market. You see, if the stock market is having positive gains, money is flowing into the market. The money has to come from somewhere, which usually means bonds. Perfect example would be, if the market as a whole is in a downward trend, you would rebalance your 401k. You would take money out of stocks, and put them in a safer vehicle for the time being, like bonds and cash. The opposite is true when the stock market is doing very well, you would take money out of bonds and cash, and move it over to try and get the positive gains of the market. In a nut shell, when bonds sell off, the mortgage rates get worse, go higher.
Back to the inflation aspect and how the Fed Rate Cuts affect our mortgage rates. The purpose of the Fed in this situation is to either help the economy fight of a recession or bring down inflation. This is a very difficult balance that the Fed has to try to accomplish. Unfortunately, they usually go too far with the rate cuts or rate increases. So, every time the Fed has cut rates in this recent cycle of rate cuts, they are trying to fight off recession.
The double edge sword of the Fed cutting rates? It is the potential of inflation to come back into the picture. Remember, inflation hurts the value of the bond in the future which in turn cause mortgage rates to go up. To illustrate this, in the recent cutting cycle, the Fed has cut 7 times since 9/18/2007. (BP stands for basis points. Roughly -100bp equates to .25% increase in interest rate) I even went against the grain when they first started cutting back in September and said to be careful about inflation. I was in the Chicago Tribune on 9/19/07 stating this. "Lower rates won't turn around housing market just yet"
Fed Rate Cut Date Size of Cut Mortgage Back Security Change -
9/18/2007 50bps -140bp in 2 days
10/31/2007 25bps -78bp in 5 days
12/11/2007 25bp -88bp in 3 days
01/22/2008 75bp -144bp in 2 days
01/30/2008 50bp -269bp in 13 days
03/18/2008 75bp -214bp in 22 days
04/30/2008 25bp +7 in 6 days
As you can see, we have actually lost a lot of ground after every cut!
However, as you notice, with the latest cut, last week, we are actually up on the price of the bond. Why? Reason being, in the Fed statement release that goes along with lowering of the rate, they had given hints that they might be done with the rate cuts and that they will keep a close eye on inflationary data. Bond traders actually liked this.
This was a quick overview of why the mortgage rates actually get worse after the Fed lowers the rates. On a daily basis there is a vast amount of information that comes out that moves these bond prices up or down.
Rich writes consistently about rate trends and often-daily rate changes on his blog - www.fcmwestloop.com/richbirablog . Call him anytime - 312-267-4859 - with any questions at all.
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