Curious Cat Investment - 30 Year Fixed Mortgage Rates and the Fed Funds Rate

See January 2008 update of this article on 30 year mortage rates.

When deciding whether to lock in a rate for a 30 year fixed rate mortgage (when refinancing or buying a new home) some believe moves in the federal reserve discount rate will raise that mortgage rate. This is not the case, in general. The effect of federal reserve discount rates on other mortgage rates (such as adjustable rate mortgages is not the same and can be predictably affected by fed fund rate moves).

The chart shows the federal funds rate and the 30 year fixed rate mortgage rate from January 2000 through September 2005 (data from the Federal Reserve web site, October, 2005: historical rate data). As you will notice there is no correlation between moves in the two rates.

There is no long term correlation between moves in federal funds rate and 30 year mortgage rates.

What is the federal reserve doing when they raise rates? The Federal reserve attempts to maintain stability in the economy by raising rates when they believe future inflation will threaten the economy. In that case, they raise rates in order to slow down the economy and reduce the economic pressures that would lead to inflation.

Could the moves by the Federal Reserve affect 30 year fixed rates? Yes, but what effect cannot be stated with confidence. It can be that the Fed announces an increase in the federal funds rate and then mortgage rates decline. Why? If investors were reluctant to buy long term bonds because they did not believe the fed was taking sufficient action to prevent inflation (for bond investors the major risk is that inflation will reduce the value of their bonds over time) in can be that by raising the federal funds rate investors will believe the fed is taking inflation seriously and will then be willing to invest in long term bonds.

In other instances the rise in the federal funds rate will coincide with increases in mortgage rates and at other times the rise will coincide with no change in mortgage rates. If someone is able to predict with accurate what will happen to mortgage rates they can make large amounts of money by making investments to take advantage of those moves in rates. It is not easy and few make money doing this not for lack of opportunity but for lack of the knowledge of the future direction of rates.

Continued - See charts for mortgage rates v. fed fund rates for the 1980s and 1990.