If the Fed Cuts, what Happens to Mortgage Rates?

by Alex Stenback on September 16, 2008

Wsj_fed_cut_916Yesterday, we pointed out the increased probability of a rate cut by the FOMC (The Fed) today.

Today, we thought it might be worthwhile to explore the "if" part of the equation. 

As in: if the Fed cuts, what happens to mortgage rates?  What if they don’t cut?

Views on this are very mixed, and this is one of the rare times that the market is not entirely certain what the Fed will do, so here’s our take.

A Fed rate cut would, perversely, push mortgage rates higher.  Investors would see a Fed cut as a positive sign and money which has been flooding into mortgage backed securities would flow back into stocks and other investments.

If the Fed stands pat, the outcome is less certain.  Mortgage rates could improve, as investors begging for a rate cut continue to shift assets into the safe haven of bonds. Or they could stay the same – the mortgage market has seen a tremendous rally, and it is uncertain how much appetite remains for mortgage-backed bonds.

Keep in mind that there is extraordinary disruption in the financial markets.  Anything, even the unthinkable, can happen. All eyes will follow the Fed’s policy statement for clues but either way they’ve got their work cut out for them.

Also, just to frame things up for everyone, the WSJ unpacks the case for, and against, the cut:

The case for a quick rate cut: Continued market turmoil could hurt an already weak economy. Mortgage rates fell last week after the government’s takeover of mortgage giants Fannie Mae and Freddie Mac, but market turmoil could push rates up for both mortgages and other consumer loans.

And..

…cutting rates now would carry its own risks. It could remove some of the Fed’s flexibility in the event that the financial crisis worsens.

We’ll be back with more as things develop.

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