Fed rate cut and mortgage rates

The Fed is scheduled to announce their latest decision regarding short-term interest rates tomorrow.  It is widely expected that they will cut the Federal Funds Rate again by .50%.

I thought it appropriate to re-post the article I wrote back in February entitled, “Why Fed Cuts Do Not Lower Mortgage Rates“.

Conventional wisdom suggests that when the Fed cuts rates that mortgage rates would fall.  However, it’s important to understand that mortgage rates ARE NOT set by policy but instead determined by the direction in which mortgage-backed bonds trade in a free market.

Since the marketplace is already expecting that the Fed will cut rates the economic effects are already priced into the mortgage rates you see today.

Furthermore, it’s important to understand that there are economic implications from a Fed rate cut that can actually lead to higher mortgage rates.

For example, in today’s WSJ.com front page Yuka Hayashi explains why another Fed rate cut could cause Japanese investors (i.e. mutual funds and insurance companies) to flea US denominated securities for fear of a weaker dollar.  Aside from China, Japan is the US’s largest foreign investor of fixed income securities.

Although the article doesn’t specifically mention how large a stake Japanese investors hold of mortgage-backed bonds it can be assumed that if this exodus occurs it would add considerable selling pressure into the market which would actually put upward pressure on mortgage rates.

Therefore, we will likely continue to recomend to our clients to lock into these low rates.