Dan Green of The Mortgage Reports Blog posted this article today in which he explains the economic theory as to why mortgage rates often rise following a Fed rate cut.
Here are a few outtakes:
*The Federal Open Market Committee adjourns from its two-day meeting this afternoon. The voting members are widely expected to lower the Fed Funds Rate by a half-percent to 0.500 percent, the lowest Fed Funds Rate in recorded history. Mortgage rates should rise in response.
*The Fed Funds Rate is an interest rate usually reserved for loans between banks, made at the close of the business one day and repaid at the start of business the next day. This is why the Fed Funds Rate is often called an “overnight rate” — the money is literally borrowed overnight. By contrast, mortgage money is typically lent for 30 years — 10,957 overnight rates strung together. It’s a completely different risk class for banks.
*That said, the Fed Funds Rate does have an indirect impact on mortgage rates because cuts to the Fed Funds Rate are meant to spur business and consumer spending, propelling the economy forward. Mortgage rates come into play because there’s always the danger that the economy gets propelled too far forward and headlong into inflation. We call this the Fool in the Shower Theory. It says that the Fed is like a guy starting up the shower and turning the knob all the way to “H”. Once the water heats up, as we’ve all experienced, it heats up quickly and the guy gets burned. So, if Wall Street thinks the Fed is over-heating the economy long-term with its rate cuts today, expect mortgage rates should increase over the next 3 days. This is what’s happened after each of the last 10 rate cuts.
Thanks Dan.