Why the Fed Cut Didn’t Lower My Rate!

Well, after much anticipation the Federal Reserve voted yesterday to drop the discount rate by three-quarters of a percent yesterday. In the minds of many on Wall Street the cut was not enough, as pressure had been mounting for a full percentage point drop. Still, by lowering the cost of borrowing money the Federal Reserve was able to motivate good activity on Wall Street, which is exactly what they wanted. The problem is that most homeowners in Utah are conditioned to expect a drop in the Fed Rate to lead to immediate drops in the mortgage rates. That simply isn’t the case.

Remember that mortgage interest rates are linked to the Bond Market. Traditionally the 10 Year Yield on the Treasury Bond has been a good indication of the direction of Mortgage Rates. In other words, as investors put money into Bonds the Mortgage Rates decrease. Similarly, as the amount put into Bonds increases the amount put into Stocks decreases. So, typically, when the bond goes up the stocks go down, and as the bond goes up the mortgage rates go down.

Yesterdays Federal Reserve moves motivated investors to put money into Stocks, which means that less money was available for Bonds. Therefore, yesterday’s action by the Fed was, in the short term, less beneficial to mortgage rates than one would have hoped.

For those who feel that the Federal Reserve cut didn’t help in any way, remember that the job of the Federal Reserve is to set monetary policy for the national economy, and that includes limiting degree of inflation. High rates of inflation means a weakened dollar, which leads to higher prices of oil, gold and other commodities. The Fed is in a balancing act between protecting the dollar (which is hard to do when the continually drop the short term lending rates) and limiting or avoiding a recession (which is hard to do without dropping the short term lending rates).

My advice: Be patient. As stocks increase investors will have more liquidity, which will translate into more money in bonds, thereby driving the interest rates down.