The Fed Raises Rates .25%.
(So why didn’t my rate go up?)

As expected, the Federal Reserve voted last week to raise rates by .25%. As a result, some people actually saw a slight IMPROVEMENT in their mortgage rate. What gives?

To understand why, let’s clear up a common misconception: The Fed does not set mortgage rates. They set the “Fed Funds” rate, the rate at which banks lend money to each other on an overnight basis.

Mortgage rates, on the other hand, are established by WALL STREET and are driven by MARKET FORCES.  There is actually no CONNECTION between the short-term cost of funds and the long term cost of mortgages. Over the last two decades, the Fed Funds Rate and the average 30-year mortgage rate have differed by as much as 5.25% and as little as .5%

But the Fed’s actions and words INFLUENCE mortgage rates. Wall Street investors analyze and parse the Fed’s statement to try to guess how their actions will influence inflation. Generally, if the Fed expresses a positive outlook on the economy, mortgage rates tend to rise. When the Fed is pessimistic, rates usually fall.

Why? It’s because a growing economy may lead to inflation, the sworn enemy of mortgage bonds. The link between inflation and mortgage rates is direct, as any homeowner in the 1980s will attest. That’s when 30-year mortgage rates went over 17%, and 15-year rates weren’t much better.

In an inflationary market, investors USUALLY move money out of the safety of boring old bonds and move it into the sexier stock market to try for higher returns. When money flees the bond market, bond prices fall, and mortgage rates go up.

So what happened? Both stocks AND bonds rallied.

“The market rallied largely because the rate hike decision today was expected and anticipated,” according to Peter Karp of Karp Capital Management in San Francisco. “With the new increase, the Fed has signaled that the economy is strong enough to stomach higher rates.”

But most importantly, it was the lack of surprise, according to Karp. “The market had already figured that the Fed would increase by .25%, and they had priced securities accordingly. When their expectations were met, they felt confident moving forward. No one was selling off any type of asset class.”

The Fed’s action will have a more direct impact on rates paid for revolving accounts, such as credit cards and home equity lines of credit, which are tied to the Prime rate, which hit 4% following the Fed’s move.

The Fed’s zero-interest rate policy has helped create thousands of jobs – more than 13 million since 2010 – and for years, price pressures within the economy remained relatively low. However, a low Fed funds rate creates wage pressure and promotes risk-taking, both of which can quickly lead to inflation, so the Fed ended its zero-rate policy in December 2015 by raising rates for the first time in nearly a decade.

However, the FED’s .25% increase in 2015 did not lead to higher mortgage rates. In fact, mortgage rates dropped nearly half a percent. Go figure!

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