Do Federal Reserve Interest Rate Cuts Affect Mortgage Rates?

Generally, Fed rate cuts most directly affect short-term interest rates and not mortgages. In fact, more frequently Fed rate cuts send mortgage rates higher. When the Fed cut its key short-term rates by 0.5% Nov. 8, 2001, mortgage rates quickly increased by almost a full percentage point. Many homeowners lost refinance opportunities because they wrongly expected mortgages to drop with the widely predicted Nov. 8, 2001 rate cut.

Mortgage rates eased a little, then spiked again shortly after the Fed’s last rate cut on Dec. 17, 2001. Conversely, mortgage rates fell from mid-May 2000 until early in January 2001 — well ahead of the Fed’s first, surprise rate cut on Jan. 8, 2001.

Still, it’s also wrong to make a direct contrary correlation between Fed rate cuts and mortgages. Mortgage rates fell almost step-by-step with Fed rate cuts July 2001 leading up to Nov. 8, 2001.

What directly affects rates?

So, if Fed rate actions don’t directly affect mortgage rates, what does? In the big picture, the overall direction of the economy has the greatest influence. If the economy is expected to grow more quickly, you can expect interest rates to rise. Why?

A growing economy generates greater interest in stocks as an investment and this draws capital away from the bond market, which includes mortgage securities. More to the point for the bond market and for mortgage rates, a growing economy brings with it more concern for inflation. Inflation is the number one enemy of fixed-income securities like mortgage bonds. With prospects for higher inflation, yields on fixed-income securities must rise to sustain investor demand.

How Can You Predict Rate Changes?

Watch the stock market, given that the stock market is our most sensitive indicator for expectations for the economy. The bond market calls this "stock trade."

Rising stock prices most often result in falling bond prices as people — investors — switch from "safe" bonds to the higher risk and higher perceived reward of stocks. When Treasury and mortgage bond prices fall, yields rise and mortgage rates directly follow these yields. This isn’t always the case — nothing with the economy is "always" the case — but is a good general rule.

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