FED RATE CUT



FED RATE CUT

It never fails, every time the Federal Reserve lowers the prime rate everyone expects mortgage rates to drop. Unfortunately the only mortgage rates the Fed has any direct control over are HELOC’s, those variable lines of credit people take out on their homes.

The Prime Rate is just the Federal Reserve overnight lending rate to it’s member banks with 3% points added on. The current Fed Rate is at 4.75%, thus the Prime Rate is at 7.75%

Mortgage rates are tied to the Bond Market. Bonds are traded on Wall Street daily and are subject to all the market forces, including market psychology (not always the most logical aspect of the trade).

Therefore the Fed Rate is set and determined by one man, with the input of the members of the Federal Reserve Board, making it a somewhat artificial rate because it is arbitrarily set by the Chairman. He makes his decisions based on overall market conditions and the economy, as such he hopes to at least influence long term mortgage rates, but that is about all he can really hope to do, influence them.

For example: When the fed rate was at 1.25%, the 30 year fixed mortgage rates were right at 4.875% this was back in the glory days during the summer of 2003. Since then the Fed has raised the Fed Rate 4% to 5.25% with a corresponding increase in 30 year mortgages of only 1.5% to 6.375% for a typical 30 year fixed. This clearly shows the disconnect between the long term 30 year fixed rates and the short term artificially priced fed rate. As a matter of fact, the 30 year rates jumped 1.5% after just the first Fed Rate increase in the summer of 2003. During the next 4 years 30 year rates have fluctuated between the high 6’s and the mid 5’s, while the Fed Rate has just continued to creep up.

This was a big concern for Chairman Greenspan as he kept raising short term rates, hoping to have a greater impact on the long term mortgage rates to slow down the excessive lending habits he saw. However, the bond market is influenced by investors world wide and he was forced to face how little impact he really had on long term rates.

This takes us up to our recent fed cut of a surprising .5%. This brought the Prime rate down to 7.75%, but only had a .125% impact on the long term 30 year rates. This was not because most of the reduction was already priced into the market it was just market euphoria getting everyone excited to buy bonds again, which drives down rates.

The proof is in the way things have played out. In just two days, the bond market corrected and bond prices are actually worse than they were before the rate cut was announced. We have actually broken through a key support level, the 200 day moving average. This could mean even higher rates if buyers don’t come back in to the market.

As you can see, bonds are like stocks, they trade according to the prevailing mood, current world news and economic forecasts, all factors much more powerful than one man’s speech. The Fed Chairman has no more control over mortgage rates than he does on the price of individual stocks, he can certainly influence them and cause euphoric buying or panic selling for a day or two, but once everyone calms down and starts to process the news, the overall market forces will prevail.

At this point the best we can hope for is that the rate cut does help the economy, and people start feeling more confident to finally pull the trigger and buy that new home. Rates are so good from a historical perspective that consumer confidence more than rate is affecting our business. However, realism indicates that the issues in our economy and overall consumer confidence are just going to have to work themselves out the hard way – through time.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download