Fed votes to keep short-term rates unchanged

As expected the Fed announced that they’d keep the Fed Funds Rate unchanged @ 2.00%.  Here is a link to the NY Times article: http://www.nytimes.com/2008/08/06/business/economy/06fed.html?_r=1&oref=slogin

Fed Funds Rate

In their post-policy announcement statement they seemed to back away from concerns about inflation.  Their comments may help ease inflationary concerns in the financial markets which would help mortgage rates.

Fed Cuts don’t necessarily lower mortgage rates

I thought it would be a good idea to post a link to my previous post which explains why Fed Rate cuts DO NOT lower mortgage rates. Here is a link to the article.

Fed cuts .75%-WSJ.com article:

Fed Cuts by Three-Quarter Point
March 18, 2008 2:19 p.m.

WASHINGTON — The Federal Reserve on Tuesday slashed its key interest rate to a three-year low and signaled more reductions are likely, unloading heavy artillery in its effort to keep the credit crunch from triggering a prolonged recession.

The three-quarter-percentage-point rate cut, though extremely aggressive by any historical measure, will disappoint many on Wall Street who thought a full percentage point was needed — a sign of the severity of the crisis that already claimed Bear Stearns and forced Fed officials to use Depression-era tools to create new lending facilities for brokers.

The Federal Open Market Committee voted 8-2 to cut the fed funds rate at which banks lend to each other from 3% to 2.25%, its lowest level since December 2004. The Fed also eased by that amount in a rare intermeeting move two months ago, which was the largest reduction since officials started targeting fed funds in the early 1980s.

Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher dissented, preferring “less aggressive action.”

The Fed also on Tuesday lowered the discount rate it charges banks and brokers that borrow directly from the Fed by 0.75 percentage point to 2.5%, leaving the spread over fed funds at a quarter percentage point.

“Recent information indicates that the outlook for economic activity has weakened further,” the Fed said in a statement, citing weakness in consumer spending and labor markets. “Financial markets remain under considerable stress,” the Fed added, and the “deepening” housing slump should weigh on the economy.

The Fed said growth risks remain and that it will act in a “timely” manner as needed, suggesting more rate cuts are probable barring an economic recovery.

As recently as a few days ago, economists had called for only a half-percentage-point reduction in the fed funds rate. Even that would have been an aggressive move coming just weeks after officials cut the funds rate by 1.25 percentage points over an eight-day period in January.

But as the financial market crisis worsened last week and economic data disappointed, investors steadily upped their rate-cut forecasts to as high as 0.75 percentage point by the end of last week.

And after the Fed on Sunday lowered the discount rate by one-quarter point, extended $30 billion in financing to J.P. Morgan to complete its takeover of Bear Stearns and announced new liquidity measures on top of others that could pump hundreds of billions of dollars into credit markets, many economists concluded that anything less than a full percentage point would disappoint markets and threaten a renewed downward spiral.

Many private-sector economists think the economy is already in a recession, albeit a mild one for the moment as consumer spending has yet to fall and exports remain supportive of overall growth.

But the signs are ominous for what Fed officials call an adverse “feedback loop” in which economic and market difficulties become self-feeding. Housing remains mired in a severe slump, as evidenced by a 16-year low reading Tuesday on homebuilding permits. Back-to-back declines in employment, weak retail sales and a surprisingly large drop in factory output suggest that housing weakness is spreading to other sectors.

Further freeing the Fed’s hand was a surprisingly tame consumer price report last week that showed no change in prices both overall and when food and energy prices were excluded. Inflation will surely rebound this month on the back of record-high oil and gasoline prices. But with the economy slowing, Fed officials expect price pressures to moderate.

“Still, uncertainty about the inflation outlook has increased,” the Fed said, and they will monitor it “carefully.”

The smaller-than-expected rate cut may also signal that officials are growing uneasy about the U.S. dollar’s decline against other major currencies, which has pushed up prices of commodities like oil that are priced in dollars.

A 0.75-percentage-point cut signals “that the Fed does not harbor benign neglect toward the dollar, as has been the impression of late,” said Miller Tabak strategist Tony Crescenzi in a research note before the Fed announcement.

Why Fed Rate Cuts do not lower mortgage rates by Evan Swanson, CMPS

The Fed is at it once again slashing short-term interest rates with the hopes of helping the economy avoid a steep recession. Many people, including so-called “experts” in the media, believe the recent Fed cuts are the reason why mortgage rates touched 4-year lows on January 22nd. However, if you look at history the results may surprise you.

Let’s first remember that the Federal Reserve can only control the Discount Rate and Fed Funds Rate. These are short-term rates used for overnight lending between banks and can change from day to day. This is very different than 30 year mortgage rates which remain fixed for a much longer period.

The last time the Fed went on a lengthy rate cutting cycle was back in 2001. In the span of 12 months (January- December) the Fed cut the Fed Funds Rate from 6.00% to 1.75%. To an uninformed consumer one would think that mortgage rates would have also decreased significantly over that timeframe. In fact, 30 year fixed rate mortgages actually increased from 6.95% in March to 7.07% in December (source: www.freddiemac.com).

In the most recent cycle, the Fed began cutting short-term interest rates on September 18th, 2007. From then until now the Fed has slashed short term interest rates from 8.25% down to 6.00%. Over that timeframe mortgage rates have come full circle starting at around 6.25%, falling as low as 5.00% in late January, and now back up to the 6.25% range in late February.

The truth is that fixed mortgage rates are wholly determined by the direction that mortgage-backed bonds trade. Mortgage-backed bonds are bonds which are sold to investors that are backed by the mortgages that you and I pay interest on. When the demand for these assets increase it drives up the price and lowers the yield. This is what causes mortgage rates to decrease and vice versa.

So, what is it that causes the prices of these assets to fluctuate? Like other asset classes such as stocks, there are many factors that we can identify. However, the primary factor is inflation expectations. If you think about it this makes sense. If you’re going to lend another person some money today and you expect the purchasing power of that money to be significantly less in the future, due to inflation, then you will charge them a higher rate of interest in order to borrow your money.

This is exactly the case for mortgage rates. When inflation expectations increase so do mortgage rates and vice versa. So when do inflation expectations rise or fall? Again, there are a myriad of factors that can influence inflation expectations including commodity prices, the economic outlook, and inflation data.

However, I would argue that mortgage rates recently touched 4-year lows not because of the Fed’s rate cut but because of the fear and concern that the Fed raised when they made their surprise .75% on the morning of January 22nd.

For now investors are beginning to realize that the implication of the “easy-money” monetary policy combined with the generous fiscal stimulus package is likely to be increased inflation.