02/29/2008 – 2:35 pm
Heres an article I found that clarifies why this may be true.
The Federal Reserve has been on a rate cutting spree once more. Many mortgage applicants are calling their mortgage representative and expecting a lower interest rate. Others who have been waiting to refinance are puzzled as to why mortgage rates have not moved lower during the recent five Fed rate cuts. This is difficult to explain to consumers who have watched a 2.25% reduction by the Fed with very little benefit in mortgage rates.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.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. This past month, 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 and mortgage bonds had little reaction – but, were unable to recover the enormous pricing loss seen back on Jan 23, the day after the surprise 75bp cut. Please refer to the Table below.
| Fed Rate Cut Date |
Rate Cut Size |
MBS Pricing Change |
| 09/18/2007 |
50bp |
-140bp in 2 days |
| 10/31/2007 |
25bp |
-78bp in 5 days |
| 12/11/2007 |
25bp |
-88bp in 3 days |
| 01/22/2008 |
75bp |
-144bp in 2 days |
| 01/30/2008 |
50bp |
little changed |
|
3 Responses to “Fed Cuts May Not Mean Lower Interest Rates”
Great post. A lot of people expect rates to drop right away once the Fed’s cut them and so often that is not the case.
By brian on Feb 29, 2008
It is nice to see the data. The reality is that when the economy is doing well investors stay away from Safe Harbor Bonds and invest where they can get a higher return. When the Fed cuts short term rates the entire purpose is to stimulate the economy, which in turn causes people to move their money from Bonds to higher yielding investments. So rates go up.
This relationship became crystal clear to me when the Fed unexpectedly cut rates by 0.75bp on 1/22/2008. Rates that morning were incredibly low because of bad economic news. I started calling past customers to let them know we could do a No Cost Conversion to lower their mortgage rate. By the time most people could return my call, rates had already gone up and the opportunity was gone. What a shock!
By Colin on Mar 1, 2008
What probably confuses most about the fed funds rate and discount rate is the effect on HELOC’s (Home Equity Lines of Credit). Most people confuse them with a regular mortgage. Changes in the fed funds rate and the discount rate also dictate changes in the Wall Street Journal Prime Rate, which is of interest to borrowers. The prime rate is the underlying index for most credit cards, home equity loans and lines of credit, auto loans, and personal loans.[reference: bankrate.com] Thus confusion with fed rate cuts are most likely related to certain loans (HELOC’s) that are often lumped together with mortgages.
By turtle on Mar 13, 2008