Archive for August 1st, 2017

Potential Shake Up at the Federal Reserve

August 1, 2017

Janet Yellen’s days may be numbered. She is the current head of the Federal Reserve, and her role is up for renewal by President Trump. While he has been coy in the past about his plans to (or not to) replace her, signs are pointing to the fact he might indeed do so.

Trump has made no secret about his desire for low interest rates. This tends to fuel stock values/growth (something President Trump enjoys), but it could cause problems down the road. It also marks a significant shift in the philosophies of our major political parties:

  • Democrats traditionally want lower rates to encourage job and wage growth.
  • Republicans tend to want the Federal Funds rate to be higher to fight off inflation.

There is another angle to consider: Ammunition for the Federal Reserve when there is another economic down turn. Lowering the Federal Funds rate is a classic monetary policy employed by the Federal Reserve to help stimulate the economy in times of slow growth/recession. We saw the Federal Reserve lower the funds rate after the “.com” bubble burst, and then raise it as the economy recovered. This repeated after the housing collapse, and the Feds are now raising the rate again to have this as a fallback position for next time (there will be a next time). If rates are kept low, the Feds won’t have this as an option. Japan have kept their “federal funds” equivalent at zero for many, many years with little impact. They recently started a “negative” rate policy that has also shown little results in getting their economy back on track.

It is a delicate balance, and will be interesting to see how it plays out.

The question that most people reading this blog want to know is how will this impact mortgage rates. Mortgage rates tend to work in opposite fashion to the Federal Funds rate.

  • the Federal Funds rate directly impacts rates on second mortgages, car loans, credit cards.
  • mortgage rates are determined by the value of mortgage backed security bonds. These bonds (and all bonds) hate inflation. As inflation rises, bond values drop. As bond values go down, mortgage rates go up.

It stands to reason that mortgage rates could improve as the Federal Reserve raises the Federal Funding Rate. That is exactly what has happened as the Fed raised rates. Mortgage rates improved after the Federal Reserve raised rates in December 2015. Mortgage rates skyrocketed after the election (when stock prices went up dramatically). Mortgage rates have improved since the Fed began raising the Federal Funds rate again at the end of 2016 and into 2017 (while stock values have been mostly flat/slightly higher).

It will be fascinating to watch how this unfolds as traditional party philosophies, the economy, monetary policy, and mortgage rates all stand to be impacted by the decision.

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