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Mortgage Rates Are Not Driven By Cuts To The Fed Funds Rate

After demonstrationg tremendous resiliency since the summer, the U.S. economy finally showed signs of breaking last week.

• Oil touched $100 per barrel igniting fears of a consumer spending slowdown
• Unemployment rates reached 5.0% nationwide
• Housing weakness nationwide is dragging on retailers' sales figures

Markets appear to have abandoned the notion of runaway growth and are now wondering "how slow?" and "how soon?". 

Coincidentally, three Federal Reserve Bank officials are speaking publicly this week and may help provide some clues.  Predictably, newspaper articles are discussing the likelihood of a Fed rate cut.

It's important to remember that when the Federal Reserve lowers the Fed Funds Rate, it is not lowering mortgage rates, too.  Instead, mortgage rates are determined by the price of mortgage bonds.

Bonds prices -- like stock prices -- are based on supply and demand and are not set by a government policy.  Just like the Federal Reserve can't set the price for IBM stock, it can't set mortgage rates, eigther.

However, the Federal Reserve can influence mortgage rates. 

This is because part of the Federal Reserve's role is to manage inflation in the U.S. economy and inflation rates are directly connected to mortgage rates.  As inflation pressures increase, mortgage rates usually rise.

So, if the Fed speakers express concern about inflation this week, expect mortgage rates to elevate.  If the speakers say that inflation pressures have subsided, expect mortgage rates to idle or fall.

Either way, whether the Federal Open Market Committee reduces the Fed Funds Rate by a half-percent, quarter-percent, or not at all at its next meeting, mortgage rates will move to their own beat. 

If the risks of inflation outweigh the risks of recession, mortgage rates should rise.

(Image Courtesy: Pro Music News)