Posts Tagged ‘Inflation’

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.

A half down. A quarter up.

September 20, 2007

Hmmm . . . A half down.  A quarter up.

pic_carson.jpg 

A baby’s midnight bottle. 

Or, what you get when the Feds lower rates; mortgage rates go UP. 

The Feds threw a bit of a curve-ball this week after their meeting on Tuesday, announcing to cut the Federal Funding rate and the Discount Rate by 0.5%.  While most economists were anticipating a cut in rates by the Feds, most were leaning towards a more conservative 0.25% cut.  As expected, talk around the water-cooler, advice from well-meaning in-laws and even the front page of yahoo.com is all a-buzz about the good news for mortgage rates and the housing market . . . a half-a percent lower, right!?  Nope.  More like 0.25% higher.

In case you missed last week’s post (and the link in that post to my article on the Feds and the Federal Funding rate), here is the short to medium answer:  the Federal Reserve is charged with helping to control inflation.  Their main tool for doing this is by raising and lowering the Federal Funding rate.  This rate  is the benchmark rate that banks use to borrower money from one another and to lend to customers — mainly on car loans, credit cards and second mortgages.  When the Feds lower the Federal Funding rate, banks lower prime rate (and the LIBOR index will soon follow for all of you soon-to-adjust ARM mortgage holders).  Banks can do business for less; consumers can borrow for less; and the cut in rates  generally helps to spur on the economy.  One the other hand, too much economic growth (and even the potential and/or fear for too much economic growth in the near future) puts pressure on the long-term return on bonds, causing bond prices on mortgages to fall, and as prices fall, the yields go up, and as the yields go up, so do mortgage rates. 

Confused yet? 

Think of it this way.  Suppose I am going to loan you money at a certain rate for 10 years.  Let’s say that I plan on making $30,000 in interest over that 10 years (I’m going to buy a car with my profits — a brand-new model year, super-cool, whatever-car).  BUT, because of inflation, 10 years from now, that $30,000 dollars will no longer be worth the same $30,000 as it is today.  In other words, because of inflation, the $30,000 car that I had my eye on today, (fast-forward ten years) now costs $36,569 (based on 2% inflation per year).  So, now, if I want to make the same profit (enough to buy that new car), I am going to have to charge you a higher rate of interest on that 10 year loan.  If I am worried that inflation is going to increase even higher than the 2%, I’d have to charge you an even higher rate.  The higher the worry (fear of inflation), the higher the rate.   I realize there are some flaws to the analolgy and a car, but (assuming the base price of a new model year car goes up at the rate of inflation) . . . well, hopefully, you get the idea.

So, while the Feds move is nice for the economy — and nice for those home equity lines of credit, credit cards and car loans — the idea of too much of a good thing (too much growth in the economy too fast), has caused mortgage rates to go up.  So where are rates headed from here??  Stay checked-in to “the Mortgage Blog” and I’ll keep you posted.  Like Carnac, I can only tell you what is coming next (rates will be higher tomorrow).  Unfortunately, I can’t see in to the future.  It’s not like I have 1.21 gigawatts of electricity and one of these . . .

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Jeffrey Pinkerton is a Mortgage Consultant and President of Hillside Lending, LLC and writer for “the Mortgage Blog.”  Hillside Lending seeks to provide mortgage brokerage services with the highest standards of service, care, honesty, integrity and value; concentrating on owner-occupied, residential financing.  For more information about available programs and interest rates, please visit www.hillsidelending.com.