The Federal Reserve’s Board of Governors has a tremendous influence on many aspects of the economy, but they do not directly control consumer interest rates. The rates the Fed can directly manage, the Federal Funds Rate and the Discount Rate, are rates associated with banks borrowing from the government or from each other. These rates influence the overall cost of money and borrowing, the effects of which ripple throughout consumer credit as well.
The impact of a rate change is rarely felt at the time of the Fed’s meeting, the decision, or the announcement. More often than not, the markets have already accounted for the Board’s decision before it has been formally made. The main goal of the Federal Reserve is to smooth out the highs and lows of economic activity. Though they tend to be more concerned with the longer view, they do not want to unnecessarily cause any immediate shockwaves on the day of their meetings either. Therefore, they will often hint at the likely outcome of the meetings through the remarks of individual Board members leading up to the meetings. Their comments, combined with the current economic indicators, usually allow the market to “price in” anticipated rate changes gradually before they occur. Most of the time, the market is more concerned with what is said in the announcement of the Board’s decision than what the decision actually is because that announcement may provide clues as to what the Fed will do at their next meeting.
Typically, the only times that a Fed rate change will dramatically alter a market is when there is unexpected news. This rarely occurs at the time of the Fed’s meetings. Instead, it may occur when one of the Board members says something unexpected in a public speech or if an important economic indicator could potentially cause the Fed to veer off their expected course.
When the Fed raises their interest rates, most other investments are forced to offer higher interest rates as well to attract big institutional investors to invest in their products. To simplify
a complex topic, mortgage interest rates are directly tied to Mortgage-backed Securities (MBS), which are huge, multi-million-dollar pools of thousands of similar mortgage notes that are packaged up and sold in pieces to many different investors. MBSs, just like any other investment product, must offer interest rates that compete with other investment vehicles with similar risk profiles. Since they must pay a higher interest rate to attract investors when those rates move up, they require lenders to charge a higher interest rate on new mortgage loans.
I hope this provides you with a better understanding of how the Fed’s actions impact mortgage interest rates. If you think you may soon be in the market to purchase a home or are considering it, do not hesitate to give me a call to discuss what the current outlook is for mortgage rates and what it could mean for you.