Your Mortgage Minute: The Fed Does Not Set Mortgage Rates

People are often nervous about locking in rates because they hear the Fed is going to raise rates so I thought I would take a minute to explain a part of the system. The Central Bank ("the Fed") is tasked with monetary policy and they have two main objectives: price stability and maximum employment.

Their primary tool for doing this is setting the Federal Funds Rate. The Fed Funds Rate is the rate for overnight borrowing for banks. (Banks are required to keep a certain amount of reserves on hand. They need to balance every evening and if they do not have the proper reserves they need to borrow from another bank or from the Federal Reserve.)

So how are mortgage rates determined? Mortgage Backed Securities (MBS) are collections of mortgages sold in the bond market. The better (higher) these trade, the lower the average mortgage rate will be. Although the Fed Funds rate does not directly affect this, the Federal Reserve's policies can have a big impact on how MBS trade. For instance, at the start of Covid, the Fed started buying massive amounts of MBS which pushed trading higher and therefore lowered the interest rates. More recently, the Fed's actions to increase the Fed Funds rate do have an impact on mortgage rates. Inflation is the archenemy of Bonds since Bonds pay investors a fixed rate over time. (Inflation erodes the buying power of your future fixed return because the cost of goods and services has increased. Meaning that the fixed amount received will purchase less in the future.) The Fed raising rates is seen as an attempt to curb inflation so the bond market generally reacts favorably to the outcome of actually lowering mortgage rates.

Clear as mud? A few key points when thinking about rates. Mortgage Backed Securities are traded throughout the day when the Market is open which means mortgage rates change throughout the day.

When you see a posted rate, it was a snapshot in time. There are multiple news events that affect how MBS trade (jobless claims, cpi, when the Fed changes the Funds Rate...) Investors speculate on the outcomes of these so very often the rates change ahead of a predicted news event rather than after. If speculation was way off base you can get a very big swing in rates.

As you can see, there are a number of complex factors that determine mortgage rates (and we haven't even started on individual factors like credit score). There is a great expression that trying to lock the lowest rate is like trying to catch a falling knife. If you are looking to buy a home or tap into your equity with a mortgage loan don't be discouraged by what you are reading in the news as rate should not be the most important factor in your decision. Contact an advisor to discuss your situation and find out what your options are.