Unless you’re one of those official “Fed Watchers” who hangs on nearly every word that comes from current Fed Chair Janet Yellen or any of the Federal Open Market Committee or FOMC members, then you probably don’t have a pretty big stake in Treasury Bills and Bonds. The Federal Reserve meets every six weeks or so and their last meeting of 2016 took place just last week on the 13th and 14th of December.
As expected, the result of this most recent round of meetings was an increase in the Federal Funds rate by 0.25%. This was the only rate move by the Fed in 2016 and matched a similar increase in December 2015.
Mortgage rates in turn have also moved upward, but not necessarily as a direct result of the December meetings. But to understand what does affect mortgage rates you need to first pay attention to what moves mortgage rates and what does not. Unfortunately there is a bit of misinformation out there and some notions just can’t seem to go away.
Let us take some time here to provide some clarity on why mortgage rates move when they do.
When the Federal Reserve meets, one of their primary functions is to help control the cost of money. They do so by adjusting what is called the Federal Funds, or Fed Funds rate. This rate is the rate that banks charge one another for very short term loans, as in overnight. Why do banks need to borrow money on such a short term basis? Banks are required to keep a specific amount of liquid capital, or cash, in relation to the amount of outstanding loans they have made including automobile loans, credit cards and student loans.
When the Fed Funds rate is low, the theory is it encourages banks to extend more credit. At the same time, as the Fed anticipates a stronger economy in the near future, the Fed will increase the cost of these overnight loans in an attempt to stave off an overheated economy, resulting in inflation. For the past several years, we have seen very little inflation whatsoever yet we also have not exactly witnessed a fire-breathing economy. Such tepid growth over the past several years has allowed the Fed to keep interest rates as low as they have been for so long. But with a recent Fed move, analysts believe the Fed believes the economy is starting to rumble just a little bit louder. In fact, at the conclusion of the most recent FOMC meetings, the announcement was made there will likely be three more such rate increases in 2017.
Bonds and Prices
Contrary to what you might read, mortgage rates are not in fact tied to the 10-year Treasury. Instead, fixed mortgage rates are tied to a specific bond that is bought and sold daily by investors worldwide. When investors think the economy is on the march, they will sell bonds, including mortgage bonds, and invest in stocks. On the other hand, when investors aren’t sure about the economy or think the economy will slow, they will sell stocks and put money into the safety of bonds. And unlike any other price vs. demand dynamic, the greater the demand for bonds, the higher the price of that bond. Yields, or interest, on bonds react in the opposite direction of the price. Higher priced bonds will lower the yield and vice versa. When the economy looks to be on a roll, the price of a bond will fall, increasing the yield. The yield is the amount of interest paid to the bondholder. As it relates to mortgage rates, a 30 year conventional fixed rate is tied to the current Fannie Mae issue, or what traders see as the FNMA 30-yr 3.0 coupon. But with fixed rates, investors don’t react to a Fed move but anticipate it.
When an investor thinks there will be future rate increases, the investor would sell the bond well in advance of those moves as the yield of the bond today would be worth more compared to the same bond six or nine months from now. This is why we’ve seen the average 30 year mortgage rate top the 4.0 percent mark for not only the first time this year but as far back as November of 2014. Mortgage rates continue to rise based upon the anticipation of future moves by the Fed.
Mortgage Rates : The Trump Effect?
Interestingly, it was initially thought by many that a Hillary victory would be good for the economy due to the perceived stability to markets an establishment candidate would provide. However, analysts now are of the notion that with Trump’s anticipated stimulus moves, especially in the near term, the economy would awaken further and begin to grow more quickly compared to an economy with no infrastructure stimulus.
When you combine the Fed’s announcement there will likely be at least three more rate increases in 2017 as a result of a stimulated economy with Trump’s planned stimulus amounting to more than $1 trillion, you can see why rates have done what they’ve done and what they’ll likely do going into 2017.
And it’s not just fixed rates that are on the move. Adjustable rates are also climbing as a direct result of Fed moves. When the Fed raises the Federal Funds rate by 0.25%, banks almost immediately adjust the Prime Rate by the same amount. Loans with adjustable rate mortgages will rise right along with Fed moves.
Your Money, Now What?
So what does all this mean for you? If you’re thinking of refinancing and hoping for lower rates, that’s probably not going to happen anytime soon. If you’re thinking of buying a home and getting a mortgage, the longer you wait the more likely it will be that rates will be higher. And sooner rather than later.
But let’s not all get too excited here. No need for “paralysis by analysis” trying to figure out the next Fed move. In reality, a 0.25% increase on a $350,000 loan is a difference of about $40 per month. That’s pizza and a movie. But should there be three more rate increases that would mean an increase of a full percentage point and that gives you a more respectable $165 per month bump.
Let’s take a quick second here and put this into perspective. If interest rates go from 4.0% to 5.0% the world won’t come to an end. In fact, such an increase would be an indicator the economy is doing quite well, thank you. But an increase in borrowing costs means less available cash consumers and businesses alike spend on goods and services and more on the cost of funds. Rates are in fact on the rise and we have likely seen the lowest rates ever in our rear view mirror. But let’s keep higher rates in perspective. Higher rates means more people are at work, wages are gaining and people are getting more out of their homes when they sell in a strong economy compared to a tepid one.