What Yesterday’s Fed Announcement Means for Mortgage Rates

by Alex Stenback on January 26, 2012

Yesterday, the Federal Reserve Open Market Committee (FOMC) wrapped a two day conclave in the usual manner – with a policy statement and rate decision.

The policy statement, in addition to reciting the usual litany of economic yin and yang (economic growth moderate in US, slowing overseas.  Employment bad, household spending kind of OK, housing in the dumps) contained some big news for rate watchers.

But before we get to that, lets rewind a little.

What Does the Fed Have to Do with Mortgage Rates?

First things first:  The Fed does not set mortgage rates (say it with me, for emphasis: The Fed does not set mortgage rates.)

That said, for interest rate watchers of all stripes, the Fed statement is important – though the The Fed only sets certain, short term interest rates (the ‘Fed Funds’ rate, and the discount rate ) their outlook on monetary policy, the economy, and inflation is hugely influential when it comes to market-based rates like mortgages.

For instance, yesterday, within minutes of the official Fed Statement, mortgage bond markets rallied toward lower rates.  That rally has followed through into today, with most lenders quoting 30 year fixed rates .125% to .25% lower than they were yesterday morning.  That may not seem like a big deal – .125% is only worth about $16/mo on a $200,000 loan, after all –  but as these things go,  it is an impressive one-day move in mortgage rates.

If you read the statement, there was nothing in there that said “mortgage rates are hereby lowered by .125%” but that is in fact what happened.  Which brings us to the next question.

Why Did Rates Drop?

For that answer, we need to look to the actual Fed Statement.  Here’s the key passage.

“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy…snip… and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. ”

So big deal right?  Let’s compare that to the last Fed Statement from Dec 13 2011:

“The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

And there you have it – the Fed has extended the “low rate” target date by a year or more – from “Mid 2013″ to “late 2014.”

Leaving aside what that says about the general state of the economy, this is a clear signal to the markets that the Fed sees neither inflation, nor economic recovery (the two things that will send mortgage rates higher) on the medium term horizon, and will maintain the course until at least late 2014.

In turn, bond markets immediately moved toward lower rates, and mortgages (or mortgage bonds) followed along.

This happens because the bond market (or any market) game is in part one of anticipation, that discounts not only present reality, but the expected reality 6 mos or more down the road. In other words – rates rise and fall based on what is happening today, but also in anticpation of future events or conditions.

So when the Fed says “Hey, rates are going to stay low for a lot longer than we said the last time” it clears the decks for market rates to move lower.

Does this mean low mortgage rates until 2014?

Not so fast.  Remember, despite all the data, degrees, influence, and high powered minds at the Fed, they can be wrong.  Markets can move against them.  This is after all the same body that could not collectively see the 700 billion dollar housing bubble 6 mos before it popped.   Think about that before you assume rates will stay this low until 2014.

Bottom line:  All we really know is that Mortgage rates will stay low until they don’t.
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