How the Federal Reserve Affects Mortgage Rates
When mortgage rates fluctuate, we often hear the Federal Reserve mentioned as one of the key factors impacting rate movements. But how exactly does the Federal Reserve influence the interest rates borrowers pay on home loans? In this blog, we’ll break down the ways the Fed can directly and indirectly impact mortgage rates.
The Federal Funds Rate
The Federal Open Market Committee sets the target range for the federal funds rate. This is the interest rate banks charge each other for overnight lending. When the FOMC raises or lowers this rate, it flows through to other interest rates, including mortgages. Typically, when the federal funds rate goes up, so do mortgage rates.
A higher federal funds rate means banks pay more to borrow money. To recoup costs, they pass on the higher rates to consumers through credit cards, loans, and mortgages. The impact isn’t always immediate but over time, the fed funds rate and mortgage rates tend to align directionally.
Bond Market Reactions
In addition to the direct impact of the federal funds rate, the Fed also influences mortgage rates indirectly through the bond market. Treasury bonds compete with mortgage-backed securities (MBS) which impacts mortgage pricing.
If Treasury yields rise after a Fed announcement about raising rates, money may shift out of the MBS market into Treasuries. The reduced MBS demand means lenders need to increase mortgage rates to attract more investors. Even if the Fed doesn’t change its benchmark rate, just signaling future hikes can indirectly push mortgage rates up through the bond market.
Inflation Expectations
The Fed has a dual mandate of controlling inflation while promoting maximum employment. When the Fed believes inflation is rising above acceptable levels, it uses monetary policy like rate hikes to slow things down. When the Fed gets more aggressive about fighting inflation, rates usually move up.
If the market expects tighter Fed policy to combat inflation, yields on the 10-year Treasury tend to rise based on inflation predictions. Since 10-year Treasury yields directly influence 30-year fixed mortgage rates, inflation outlooks impact expectations on where mortgage rates are headed.
The Federal Reserve impacts mortgage rates both directly through the federal funds rate and indirectly through investor reactions in the bond market. Understanding the Fed’s goals and monetary policies can provide insight into the housing market and where rates may trend in the future.
