The Federal Reserve Open Market Committee (FOMC) meets at least eight times per year to discuss and vote on US monetary policy. The Fed controls the Fed Funds rate, which is essentially a bank’s cost of money. When the Fed increases the Fed Funds rate, short-term interest rates such as the Prime rate and LIBOR go up. These are often used to determine interest rates on adjustable rate mortgages, home equity lines of credit, credit card balances, and business loans.
However, interest rates on fixed-rate mortgages are not tied to changes in the Fed Funds rate. Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market. When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other “securitizers”. These “securitizers” get their money by issuing bonds to bond market investors. These bonds are called “mortgage bonds” or “mortgage-backed securities”. Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market. As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive interest rates down and stimulate the economy. Currently, the Fed owns a whopping $1.6 TRILLION in mortgage bonds!
In fact, the Fed has been the biggest buyer of mortgage bonds in recent years. This had the impact of keeping interest rates very low. In October 2017, the Fed began reducing its bond purchases, and by October 2018, the Fed’s mortgage bond buying program had undergone a near-complete wind-down. In March of this year, the Fed indicated that it would not be increasing rates any further this year and that it may gradually resume its Treasury bond-buying program over the next several months. Shortly thereafter, mortgage rates fell, and the 10-yr Treasury yield broke below 2.5% for the first time since January 2018. While the Fed is resuming its Treasury-bond buying program, the Fed won’t be taking the same approach with mortgage bonds. In fact, the Fed has even indicated that it may decide to start selling off its portfolio of mortgage bonds at some point. That said, it’s unclear at this point whether mortgage rates will decline further as a result of the Fed’s purchase of Treasury bonds.
Please contact me for further details or for real-time analysis of how mortgage bonds are trading today.