Mortgage

By way of the Federal Reserve, the FOMC, and the Fed Funds Charge

What is the Federal Reserve?

The Federal Reserve is the central bank of the United States of America. It manages the country's currency, interest rates, and money supply.

The Fed affects the American economy in many ways. Most consumers, however, pay special attention to the Fed setting interest rates.

When the Fed raises or lowers interest rates, things like business loans and credit cards are directly affected. And things like mortgage loans are indirectly affected.

That means tens of thousands of borrower dollars will be at stake if the FOMC meets, as it does this week.

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What is the Federal Reserve doing?

Under its charter, the Federal Reserve has two explicit (and related) goals.

The Federal Reserve and Employment Rates

The first goal of the "Fed" is to promote maximum employment in the US economy.

In economic terms, “maximum employment” means that all labor resources within the economy are used as efficiently as possible.

In plain language, this means that anyone looking for a job can find a job with decent pay. This does not mean that the unemployment rate is zero, as there are people in every economy who work between jobs or are voluntarily unemployed.

The Federal Reserve and Inflation

The second goal of the Fed is to seek price stability within the economy.

“Price stability” is measured in terms of inflation. This is the rate at which the cost is changing.

For consumers, inflation is felt more often than it is measured. When there is inflation, prices go up.

In other words, when there is inflation, your dollars won't go as far as they used to. More money is needed to buy exactly the same goods and services.

Inflation rates were the highest in the 1980s.

Consumer price inflation since 1970. Source: St. Louis Fed

The Federal Reserve is aiming for an annual inflation rate of nearly 2 percent.

If inflation rates exceed two percent too much, it can hurt the US economy. Consumers suddenly run out of money to buy basic goods and services and many begin to struggle with debt.

In periods of inflation, workers often demand increases, resulting in higher costs for businesses, which in a self-reinforcing cycle leads to even higher inflation rates.

The Federal Reserve and Deflation

However, inflation can also be too low; well below the Fed's 2% target. Low or negative inflation in the economy is known as deflation or disinflation.

In times of deflation, consumer prices will fall and then further. Now, falling prices may be a good thing, but when prices continue to fall, consumers “push back” large purchases because prices will be lower in the future.

By postponing large purchases, consumers are forcing businesses to lay off workers, putting additional pressure on wages and prices.

Deflationary spirals are just as damaging as inflationary ones.

For mortgage buyers, however, deflation is beneficial. Mortgage rates fall in times of deflation. However, inflation drives up mortgage rates.

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What is the FOMC? (The Federal Open Market Committee)

Within the Federal Reserve, there is a 12-person committee for setting guidelines called the Federal Open Market Committee (FOMC). Eight planned meetings of the FOMC take place every year.

After each of its eight meetings, the Federal Reserve issues a press release known as the "FOMC Statement" that summarizes the central banker's policy choices.

The FOMC and the Fed Funds Rate

The FOMC's best-known monetary policy choice is the setting of the Federal Funds Rate. The Fed Funds Rate is the rate at which banks borrow money from one another overnight.

If the Fed votes to increase the Fed Funds rate, the costs for consumers and businesses will rise, which will weigh on the US economy. Conversely, if the FOMC votes in favor of lowering the Fed's key rate, the economy will be pushed to expand.

Federal Funds Rate vs. Consumer price inflation, 1970-2018

Consumer Price Inflation and Fed Funds Rate. Source: St. Louis Fed

The Fed Fund Rate is also the basis for the “Prime Rate”.

The FOMC and the Prime Lending Rate

The base rate is a base rate for consumers and US businesses. The Prime Rate is used to set credit card interest rates and the cost of business loans.

The key interest rate is usually the Fed's key rate plus three percent.

The Fed Funds Rate and the Bank Prime Lending Rate. Source: St. Louis Fed

The Federal Reserve also uses other tools to influence US economic growth, including the discount rate, which is the overnight rate at which banks can borrow money from the Federal Reserve. and special programs like quantitative easing.

Quantitative easing is a process by which the Fed buys mortgage-backed securities (MBS) and other bonds in the open market in order to lower bond yields and daily mortgage rates.

The FOMC has applied quantitative easing three times since 2009, and each time mortgage rates have been lower.

The Fed's second QE program coincided with the lowest 30-year mortgage rates in history. The Fed's third round of quantitative easing had a similar effect.

It is important to recognize, however, that the Fed's impact on mortgage rates is indirect.

The Fed doesn't set mortgage rates for consumers, although it does affect the direction they go. Mortgage rates are made on Wall Street.

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Fed and US mortgage rates

The Federal Reserve does not directly control mortgage rates. However, it does affect the direction in which mortgage rates go. This is because, as the nation's central bankers, the actions of the Fed and its rhetoric are closely monitored by Wall Street.

One of the “actions” the Fed can take is setting the Fed Funds Rate and the Discount Rate. and setting up programs such as quantitative easing.

However, it is the determination of the Fed Funds Rate, the Fed's most famous instrument. When the Fed decides to raise or lower the Fed's policy rate, the group sends a very specific message to Wall Street.

If the policy rate hikes, it will be a signal that inflationary pressures in the US economy are mounting and maximum employment is approaching – both of which point to economic expansion.

Note that mortgage rates tend to rise around the same time the Fed raises rates.

It does so because the Fed generally only raises interest rates when inflationary pressures rise within the economy, and because inflation depreciates the mortgage-backed securities on which mortgage rates are based.

In addition, the conditions that lead to a rate hike by the Fed funds should also attract investment dollars in the equity markets. In this case, the demand for MBS can decrease, which leads to an increase in mortgage rates.

But even if the Fed doesn't raise the Fed Funds rate, mortgage rates can move. This is because Wall Street is often as interested in what the Fed says as it is in what the Fed does.

Fed comments pointing to future rate hikes or economic expansion tend to have a negative impact on low mortgage rates. and reluctant comments will help drive rates down.

The Fed speaks to the public all year round.

In between FOMC meetings, members of the Federal Reserve speak to Wall Street, business associations, and the press. Issue statements on the economy and future monetary policy. These comments will help shape the current mortgage rates.

The Fed also publishes the Fed Minutes, a summary of the discussions and debates at its last FOMC meeting. Fed Minutes are released three weeks after an FOMC meeting is adjourned and often obscure 8,000 words.

The Fed Protocol also provides feed to Fed watchers around the world and affects daily mortgage rates.

What are today's mortgage rates?

The Federal Reserve does not set US mortgage rates, but its words and actions influence it.

Get Today's Live Mortgage Rates Now. Statements and actions by the Fed are always involved and can affect markets unexpectedly.

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