Interest rates are most affected by the bond market, and the bond market is most strongly influenced by the Federal Reserve (also known as the Fed). So when the Fed says it expects interest rates to be “zero” at least until the end of 2023, does the same apply to mortgage interest rates?
That would be nice, but unfortunately, it is no how it works. The Fed cut its interest rate to 0% in March – the same place it was nearly 6 years after the financial crisis. At that time, interest rates were in a completely different territory and they often moved to the opposite direction since then.
Given this, how can we say that the Fed is so important to the bond market and interest rates?
First, there is a evidence in the diagram above. Although we can emphasize time frames in which the two percentages move in opposite directions, it is no coincidence that they usually move higher together in 2017-2018 and decidedly lower since then. The correlation really is a lot more reliable over such long periods of time, but for those interested in the here and now, the Fed’s interest rate does us little good.
This is actually quite understandable, given that the Fed manages the rates overnight transactions between large financial institutions. This is a completely different scenario than a 30-year fixed mortgage and, as we know, different scenarios (and especially different time frames) have a big impact on interest rates.
Fortunately, the Fed’s interest rate is only one of its policy instruments. Far more important for the mortgage market are the current purchases of mortgage-backed bonds. This is the key reason why interest rates are so low and stable. In fact, buying Fed bonds would allow interest rates to be even lower than they already are, but mortgage lenders had to put the brakes on to cope with the volume.
In other words, lenders are not necessary to reduce levels faster because they are already as busy as possible. This can change, but it does not change quickly. There is also no guarantee that the mortgage bond market will be so strong in a few months. As such, it is OK to hope for gradually lower interest rates, but it is not safe to rely on them.
If nothing else, we see percentages more likely to move HIGHER in the last month – largely around the new unfavorable market fee for all conventional refinancing. There was a big jump after the initial announcement in early August, followed by a recovery after the fee was delayed a few weeks ago. Now that we have reached the time frame in which lenders have to reimburse the fee, interest rates have risen rapidly for these lenders. Others will soon follow suit. These tariff jumps come as no surprise to readers of this newsletter.
The saving grace is for those who want it BUY house instead REFINANCING one. Although the new fee has damaged the overall prices, technically it is NOT charged on purchases and in fact the purchase prices have done much better. Even before the fee was announced, some lenders were already offering much better purchase prices.
Combine historically low interest rates with delayed demand due to spring quarantine measures and the housing market rebounded with revenge. Almost every week brings new data to support this claim. The most impressive example this week is the confidence of home builders.
The new housing numbers from the Census Bureau have also been updated. Although still close to their highest levels since 2007, they have not grown in the same way as builders’ confidence.
This may reflect high material costs or simply a construction industry operating at capacity.
This may be the beginning of the phenomenon we discussed a few weeks ago, when the delayed demand to buy a home began to run before it cooled to the end of the year.
No matter what happens in the coming months, much of the recent strength of the housing market is possible from Federal Reserve bond-buying programs. Forget the Fed’s interest rate. Fed bond buying programs mean that interest rates are 0.6 to 1.2 percent lower than they would otherwise be, and infinitely easier to obtain. The fact is, we really don’t know what the mortgage market would look like right now if the Fed didn’t intervene in March. Before that, interest rates were rising at the fastest pace … ever.
And with that, we finally came to the conclusion of what the Fed’s announcement this week has for mortgage and housing markets. The Fed’s 0% funding rate is just one expression of their commitment to policies designed to help strengthen the economy. Although it doesn’t take the headlines as easily as “0% by 2023,” the Fed has reaffirmed its commitment to buy bonds in the coming months, “at least at current rates.” So, although mortgage rates are not 0%, the Fed keeps them as low as possible to a second order. Whether it will be months or years will depend on the pace of economic recovery and the extent to which the coronavirus is permanently changing the global economy.