WeeklyBasis 10/31/07: Mortgages Up After Fed Cut

As you know by now the Fed cut 2 key rates each by .25% today, and warned markets against banking on further near-term cuts. They said that while housing weakness may be a continued drag on the economy, consumer inflation, especially in food and gas, is still a threat. The initial market reaction is that mortgage rates are higher. Mortgage markets (meaning bond markets) will react further to a consumer inflation report Thursday and the all-important employment/wages report Friday. Below is more information on how Fed decisions affect mortgage rates. The Fed adjusted two rates today. The “Fed Funds Rate”, a rate Federal Reserve banks charge each other for overnight loans, was cut .25% to 4.5%. The “Discount Rate”, an 1-to-30-day rate the Fed charges global banks for short-term loans in times of distress, was also cut by .25% to 5%.

Remember that the Fed Funds Rate and the Discount Rate do not directly impact mortgage rates, with one exception. The only consumer mortgage rate that moves exactly according to Fed Funds Rate moves is a Home Equity Line of Credit (HELOC) 2nd mortgage. HELOCs are tied to the Prime Rate which is Fed Funds plus 3%. So anyone with a HELOC 2nd mortgage will see a .25% rate decrease on their next statement.

All other mortgage rates are based on trading in bond markets, which reference the Fed Funds Rate and Discount Rate for influence, but are not directly correlated to moves in these Fed rates. Just like mortgage rates increased today after the Fed rate cuts, the same thing happened after the Fed cuts on September 18. The reason is that bond markets priced in too much of a Fed rate cut in advance. After the Fed said inflation is still a threat and future cuts may not happen, bond markets (and thus mortgage rates) sold off accordingly. When bond prices drop in a selloff, yields (or rates) rise.

I will keep you posted about the status of locks or quotes as the week’s remaining economic reports are released. Please give me a ring in the meantime if you have any questions.