Fed Cuts, Signals Pause: How Will This Impact Mortgage Rates?

by Alex Stenback on May 1, 2008

The Federal reserve board o governors voted to cut the Federal Funds and Discount Rate by .25% yesterday.

Notable of course was the statement, more than the cut, which seemed to telepgraph a pause to the cutting spree begun last September.  From the WSJ:

In a statement the Fed indicated that, although the economy remains under stress, the "substantial" rate cuts and other measures it has taken to lubricate the financial markets have reduced the risk of a severe recession. That language suggested that the Fed intends to pause in its rate-cutting while keeping the door open to more cuts if the economic outlook deteriorates.

Recall that after starting last September, the Fed has now cut rates by 3.25%, yet mortgage rates have only improved by about .75%, (and often worsened immediately after the cuts.)  Remember, the Fed does not set mortgage rates – they are based on the price of mortgage backed securities.  That said, mortgage rates are higher than they normally would be with the Fed funds rate at these levels. There are two reasons for this:

1. Credit market instability: Kept rates from falling as the market priced-in more risk for all types of home loans.
2.  Inflation: All being equal, inflation will cause mortgage rates to rise.

So here’s where it gets interesting.  Because the Fed has now signaled a pause, and suggests that credit markets may begin firming this year, we may actually see rates improve on this news.  Though it is still early, we have already seen this start to play out, as mortgage bonds have seen some slight improvement since yesterday’s announcement. 

Of course, conditions in the mortgage and real estate markets are still highly stressed. We expect credit, property, and other mortgage underwriting guidelines will continue to tighten this year; so even if rates fall, this may slow any housing market recovery and dampen the impact of lower rates for many classes of borrowers.

{ 1 comment… read it below or add one }

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