Today the Fed cut both the Fed Funds Rate and the Discount Rate by .50%. Does this mean that we are going to see mortgage rates drop by a half a percent?
First let me define the Rates that were cut today. The Federal Funds Rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The Discount Rate is the interest rate charged to commercial banks and other depository intitutions on loans they receive from their regional Federal Reserve Bank’s lending facility–the discount window. Also both of these are generally overnight rates, very short term lending.
When the Fed lowers the Fed Funds rate, it cause the Prime Rate to drop. The Prime Rate is generally defined as 3 percentage points above Fed Funds. So for consumers who have a home equity line of credit (HELOC) that floats with prime, their rate should go down by .50% today.
But for long term fixed mortgage rates it is a different story. The rates for these products come from the trading of mortgage bonds, also known as mortgage backed securities. Since these are long term securities, inflation effects their value. What the Fed did today, historically is seen as inflationary and can weaken the Dollar. Inflation eats away value of the investment and investors will require a higher rate of return. That translates to higher mortgage rates for you and me. And true to history, in the afternoon the bond market sold off and I have started receiving notices of lenders raising mortgage rates.
My long term view for this market is that rates should come back down, once order and trust are re-established in the markets. And even though I mentioned inflation above, I bought gas today for $1.99 a gallon!!! I don’t think inflation, even with this rate cut, is currently a problem.
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