Fed Rate Cuts Don't Mean Lower Mortgage Rates

Last week a client from Palomino Valley informed me that he had recently watched the news and heard that, Ben Bernanke, the Chairman of the Federal Reserve planned on keeping an accommodative stance in regards to interest rates.  Mr. Bernanke's stance was that the Fed would neither lower nor raise interest rates.  My client was extremely pleased with this knowledge until he called and found out that since the June 3rd announcement mortgage rates had increased from 5.75% to 6.625% while mortgage backed securities lost 154bp (mortgage rates are inversely related to the price of mortgage bonds/mortgage backed securities).  So the question should be asked, is a Fed rate cut really good news for mortgage rates?

The facts may be surprising. The Fed can only control the Discount Rate and the Fed Funds Rate. This is very different from mortgage rates.  A mortgage rate can be in effect for 30-years while a rate set by the Fed can change from one day to another.

It is often said history repeats itself. And if history is any teacher, we can learn from what happened to mortgage rates the last time the Federal Reserve was in a rate-cutting cycle.

The last time the Fed was in a lengthy rate cutting cycle was back in 2001 from January 3, 2001 to December 11, 2001. In the span of 11 months, they cut the Fed Funds rate 11 times with eight of those cuts by 50bp. This resulted in a total of 475bp or 4.75% in short-term interest rate cuts taking the Fed Funds Rate from 6.00% down to 1.75%. Now most uninformed people would naturally think because the Fed cut rates by so much during this time that mortgage rates would follow suit and trend lower as well. Not so.  Mortgage rates actually moved higher during this time of significant rate cuts because inflation, the arch enemy of bonds, gradually rose similar to what we are experiencing today.

Now let’s take a look at what happened with the Fed’s most recent cutting cycle, the first since 2001. On September 18, 2007 the Fed cut the Fed Funds Rate by 50bp. The mortgage bond market briefly enjoyed a “knee-jerk” reaction to the Fed move by closing higher that day, but lost 140bp over the following two sessions. Then on October 31, 2007 the Fed lowered the Fed Funds rate by 25bp. The mortgage bond market responded by losing 78bp over the following five trading days. On December 11, 2007 the Fed once again lowered rates by 25bp and the mortgage bond market lost 88bp in the next three days. So far this year, the Fed delivered a surprise 75bp rate cut on January 22, 2008 and mortgage bonds lost a whopping 144bp in just 2 days. Eight days later and as widely expected, the Fed cut rates by 50bp. Within 13 days from that 50bp cut, mortgage bonds lost 269bp. On March 18, 2008 the Fed cut by 75bp and mortgage bonds lost 113bp in 6 days and 214bp in 22 days.

I really hope that this information helps dispel some myths and misconceptions.  The lesson in this data is that it is important to seek the opinion of an industry professional in your local market.  My Reno client would have benefited greatly from this advice by saving over $300 a month on his mortgage payment.

Jason Norris, MBA, CMPS, President MFG Mortgage Services, LLC 1.775.322.0496

Comments

[Ryan Elliott]

Good stuff Jason, thanks for clearing this up. I know many people get confused by this.