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The Fed Sends Mixed Messages

First, let’s look at today’s announcements by the Fed….

  1. As expected, they held the Fed Funds Rate constant (more on what that means later).
  2. They re-affirmed their prior pledge to stop purchasing Mortgage Backed Securities by March 31.
  3. They said that they expect rates to stay in this range for an extended time.

As was presented on Tuesday, by the KCM Crew in this space, the elimination of the major purchaser of MBSs is a precursor to HIGHER RATES….likely in a quick and dramatic fashion. People, DO NOT BE CONFUSED.  Many of you will hear that The Fed said “rates will stay low for an extended period of time”, so how can mortgage rates go up???

There is a popular misconception that The Fed controls mortgage rates.  Alas, they do not.

The Fed controls The Fed Funds Rate which is merely an overnight rate at which banks can borrow from The Fed (or each other) to keep them sufficiently liquid.  The Fed Funds Rate is the basis of a bank’s Prime Rate (which is typically 3% above The Fed Funds Rate) and is primarily the rate banks charge their good commercial customers who borrow money on lines of credit (the bank makes a 3% profit margin).

When the Prime Rate is low, as it has been for quite some time, commercial customers of the bank are more likely to borrow money, and use that money to expand their businesses, buy inventory, hire people, etc. or even just lower their interest costs (and drive more income to the bottom line).  All of which looks good for the business.  That is why when The Fed lowers The Fed Funds Rate, the Stock Market rallies…..because people who invest in the stock market like when businesses expand or increase the bottom line, and they buy more stock.  And conversely, when The Fed raises rates, businesses likely cut back on expansion plans and have higher interest expense; therefore, the stock prices tumble.

But what about mortgages? Understand that there is a fixed amount of money in the world.  When there is an influx of money into stocks, it has to come from somewhere.  A portion of it will be money that is in the bond market.  Money that would normally be spent on buying MBSs, instead goes to buy stock.  That forces the sellers of MBSs to raise the rate of return on their investments to attract buyers back into the bond market.  That phenomenon forces rates up.  In fact, it is normal for mortgage rates to go up when The Fed lowers rates.

That being said, while The Fed’s language talks about keeping rates low, THAT was a signal to investors in the stock market….NOT a signal to home buyers about rates.  Rates ARE GOING UP. Period!  It’s just a matter of how much and how soon.

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For more info on the impact of the Fed ending the program to purchase MBS, please read the blogs:

What Happens When the Fed Exits the Market?

Interest Rates Balloon! Up, Up and Away?


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Trackbacks & Pingbacks

  1. […] in their belief that rates will stay low for an extended period of time.   As explained in a previous blog, the Fed does NOT control mortgage rates.  Their impact is felt in the stock market.  Low rates, […]

  2. […] exiting from their program of buying mortgage backed securities (MBS) on March 31 this year as they announced they would last Wednesday. There seems to be some people who do not believe that the Fed’s exit […]

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