Many people have recently asked, “What’s going on?” The Federal Open Market Committee (FOMC) increased rates on Wednesday, December 16, 2015 and mortgages rates have fallen since then. While it is not entirely intuitive, there are some sound explanations for what has occurred. Although we often generically speak and state “The Fed raised interest rates”, there are a multitude of interest rates at different terms. The FOMC only targets the rate for the Federal Funds Rate, which is a short term (overnight) lending rate. Secondly, there is the term structure of interest rates or the yield curve. This is really just a way of referring to the relationship between interest rates or yields at different terms or maturities. Interest rates, which are shorter in term in relation to the Federal Funds Rate, are most likely to move similar directions. The duration or term is the difference between the Federal Funds and mortgages.
While “the FOMC raised rates” is the headline news and often what we speak about, that is only a piece of the story. Rates on mortgages are not always affected by the FOMC’s changes, because the FOMC is only targeting the rate at which the banks lend reserve balances to other depository institutions overnight. Mortgages, however, being long-term, are often more impacted by expectations about long term.
Long term rates moved in the opposite direction and fell. This is due to expectations playing a significant role in markets. Mortgages, U.S. Treasuries, corporate bonds, stocks, or anything else are always forward looking into distant future maturities. That is to say that expectations of the future play a significant role in determining current values. Unexpected news will likely have a more significant impact than news which was expected and widely anticipated. This certainly occurred last Wednesday. The markets had already built that into the various instrument pricing. Longer term rates fell as the language of the FOMC’s announcement was largely interpreted to mean odds are against another rate hike from the FOMC in the first half of 2016.
This is not the first time that mortgage rates have moved in the opposite direction as the Fed Funds Rate. The FOMC changing the targeted rate is a distant memory for many of us. As an example, see the graph below from the May 2004 to October 2006 time frame. While the values may be difficult to view, what can readily be observed is that as the Fed Funds Rate (blue stairs) increased steadily, while the 30 year mortgage rate (yellow line) fluctuated.
By: Michael Borodinsky
Vice President/Regional Builder Branch Manager | Caliber Home Loans
Call Michael: 732-382-2654
Email Michael: Michael.Borodinsky@caliberhomeloans.com
Follow Michael on Twitter: @mikeborodinsky