Last week, the Federal Open Market Committee (FOMC) decided to raise the federal funds rate. The federal funds rate is the interest rate that is charged to banks for borrowing overnight funds to maintain the required target funds. Although the Fed interest rate increase means that a banks’ business is getting more expensive, it doesn’t necessarily mean that mortgage interest rates increase in kind.
If mortgage rates are not always affected by the Fed’s interest rate increase, then what is?
Katherine Reynolds Lewis pointed out that the FOMC’s interest rate hike indirectly influences jobs, wages, prices of the things we buy, and other items (7 ways the Fed’s decisions on interest rates affect you; bankrate.com; March 20, 2018). She states, “Sometimes mortgage rates go up when the Fed increases short-term rates, as the central bank’s action sets the tone for most other interest rates. But sometimes mortgage rates fall after the Fed raises the federal funds rate.” An example of this is the seventeen rate increases during 2004-2005 when mortgage interest rates initially dropped, then slightly increased a year later. And most recently, the three Fed rate increases during 2017 when mortgage interest rates remained stable.
The reason why a FOMC interest rate increase doesn’t always affect mortgage interest rates is because mortgage interest rates are tied to the bond market. The bond market is typically a bellwether of the economy. It is highly likely that the bond market baked in last week’s Fed’s rate increase prior to the FOMC announcement. Bond yields have already been increasing due to an improving economy, which pushed mortgage rates higher in recent weeks.
In fact, the Freddie Mac Press release the day after the Fed’s announcement indicated that mortgage rates increased one basis point (freddiemac.com; March 22, 2018):
“The Fed’s decision to raise interest rates by a quarter of a percentage point puts the federal funds rate at its highest level since 2008. The decision, while widely expected, sent the yield on the benchmark 10-year Treasury soaring. Following Treasurys (sic), mortgage rates shrugged off last week’s drop and continued their upward march. The U.S. weekly average 30-year fixed mortgage rate rose 1 basis point to 4.45 percent in this week’s survey.”
Immediately following the Fed’s interest rate increase, NAR’s chief economist, Lawrence Yun, stated “We are in the middle innings of monetary policy normalization (nar.realtor, March 21, 2018).” Yun believes that the labor market is pushing the Fed to act to stave off inflation. He stated that consumers should expect more rate increases throughout 2018. However, he believes that increased new construction can belay future Fed rate increases:
“Housing costs are also rising solidly and contributing to faster inflation. The one thing that could slow the pace of rate increases would be to tame housing costs through an increased supply of new homes. Not only will more home construction lead to a slower pace of rate hikes, it will also lead to faster economic growth. Let’s put greater focus on boosting home construction.”
Yun’s call to home builders to increase housing stock is preaching to the choir. The housing market’s tight sale inventory should already be spurring home builders to crank out new homes. But there are challenges. The latest new construction statistics released by the US Census (census.gov) indicated that building permits issued during February were 5.7 percent lower than January’s permits, but 6.5 percent higher than last February.
By Dan Krell
Copyright © 2018
Original published at https://dankrell.com/blog/2018/03/29/interest-rate-increase-dont-panic/
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