December 10, 2018
We’ll soon have the last Federal Reserve Open Market Committee meeting of 2018. It is not the case that the actions of the Federal Reserve have substantial impact on mortgage interest rates. The Federal Reserve is the central bank of the United States and acts as a reserve bank and requires member banks to keep about 10 percent of their customers’ checking and savings deposits at the Fed. At best, the Fed’s impact on mortgage rates is indirect, inconsistent and relatively small. Orion’s brokers, however, should keep in mind that the same economic metrics that drive the Fed’s decision making also drive long-term interest rates.
The Fed is essentially the world’s largest piggy bank. It controls the money supply, affects short-term interest rates and helps regulate commercial banks. The Fed has significant objectives and powers, which it wields on a day-to-day basis, and in that category the FOMC dictates the target for the federal funds rate, which is the rate at which banks lend excess reserve balances to other banks on an overnight basis. Whenever the Fed adjusts the federal funds rate, banks change their prime lending rate accordingly. The primary direct effect on mortgages from these adjustments is on some adjustable rate mortgages that are pegged to that prime rate. For the most part, the mortgage products impacted by changes in the prime rate are home equity lines of credit.
The Fed is currently in a rate-hiking mode, but many believe that this is fading. In the current economic cycle, the Fed’s message is as follows: “With unemployment this low, we are really concerned about inflation.” That outlook may fit with the traditional notion that once the unemployment rate falls below a certain level, wage inflation, and consequently price inflation, is inevitable. The fact is, however, that is not happening.
Since mortgage rates tend to track the 10-year Treasury yield, the ability of the Fed to affect mortgage rates comes down to how the actions and words of the Fed affect investors buying and selling of 10-year Treasury debt. The ability of the Fed to affect mortgage rates through federal funds policy is very small. In fact, many overestimate the ability of the Fed to affect the economy in a major way. The underlying reason is that what has long-term effects on the economy is not monetary policy as set by the Fed, but rather unsustainable fiscal policy, which is managed by Congress and the White House. If we are going to consistently add $1 trillion to the national debt every year, then monetary policy is essentially an afterthought.
Orion’s brokers should remind clients that although the Fed’s move will grab the headlines soon with its expected rate increase, it does not set 30-year mortgage rates.