Why do mortgage rates go up when the Federal Reserve cuts rates?

from Brian Woolley
Countryridge Financial, a subsidiary of Metrocities Mortgage

The Federal Open Market Committee lowered the Fed Funds Rate to 2.250 percent yesterday while leaving the door open for future rate cuts.

Stock markets cheered the Fed's move; the Dow Jones Industrial Average rallied 400 points in the wake of the announcement.

Meanwhile, the cash that fueled the stock gains had to come from somewhere and one of those places was the bond market. It's no surprise, therefore, that following the FOMC's press release, 30-year fixed rate mortgages spiked by 0.250%.

Stated more clearly: The Fed cut the Fed Funds Rate and mortgage rates went up.

Every time that the Federal Reserve cuts the Fed Funds Rate, it's an explicit signal the economy needs a trickle-down jumpstart.

When the Fed Funds Rate is lower, doing business is cheaper for banks, who in turn make it cheaper for businesses to do business, who in turn make it cheaper for consumers to live life.

This process can take up to a year for each rate cut or rate hike.

Meanwhile, as the changes to the Fed Funds Rate trickle their way through the economy, carrying on ordinary, day-to-day activities gets "cheaper" for everyone in the country. There's more money left for discretionary items, or investment in capital items, or whatever.

For example, the Federal Reserve has cut the Fed Funds Rate by 3.000 percent since September.
American consumers borrow $2.5 trillion on their credit cards so the 3-point reduction equates to $75,000,000,000 in interest payment savings.

You can only imagine what the reduction can do for businesses because businesses borrow far more money than consumers.

So, when the Fed cuts rates, its hope is that most of these "savings" get pumped back into the economy somehow. This is how rate cuts can lead to economic growth .

Sometimes, though, the growth is uncontrolled.

The fancy word for this situation is "inflation" and inflation is the enemy of mortgage bonds; it erodes the value of U.S. dollars and that's the currency in which mortgage bond payments are made.

So, it makes sense that mortgage rates rise when the Fed cuts the Fed Funds Rate. By stimulating the economy, the Federal Reserve is making long-term inflation much more likely.

Some people think the Federal Reserve is foolish right now but the FOMC voters don't seem to care. They are more concerned with relieving short-term pressures on the economy and will deal with what comes later, later.

Even if it's runaway inflation.


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Countryridge Financial is associated with Keller Williams VIP Properties in Santa Clarita