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What Does it Mean When the Fed Raises Rates?

Will the Fed Raise Rates?  Yes, and no.

 

On Wednesday, March 16, the Fed will take an economic action that hasn’t been seen in years when they, as expected, raise the Fed funds rate.  The targeted funds rate has been set at 0-.25% for years, and next week, this is expected to change.  With this change, you’ll see plenty of headlines, social media posts, and marketing pieces from financial companies, along with lenders and Realtors touting the rate increases as a reason to ‘act quickly’ on mortgage or real estate transactions, tying the Fed’s rate activity to mortgage rates and the cost of home financing.
For most professionals, the concept of the Fed funds rate is an area of ignorance.  Like consumers, they hear “rates rising”, and assume it means that, well, rates are rising.  But in reality, the Fed funds rate is not – I repeat, not – let me say it louder for the folks in the back – THE FED FUNDS RATE IS NOT DIRECTLY CORRELATED TO MORTGAGE RATES.  Anyone that says otherwise is either ignorant to the topic, or intentionally being deceptive – neither is good!
The increase of the Fed funds rate is an increase to the rate which banks borrow from the Fed and each other.  It is not the rate consumers see or are offered.  When the Fed makes money banks borrow more expensive, it tends to slow borrowing, and through our complex economic system, tends to slow the economy at large, making an increase to the Fed funds rate one of few ‘weapons’ the Fed has to fight inflation.  If you’ve checked the news in the past year, inflation has been one of the biggest headlines of the year, with the cost of just about everything on the rise it has effected just about everyone and every part of the supply chain.  One thing most people don’t realize that almost always increases with inflation is the rate on mortgages.  Since inflationary numbers have hit the 7% range, the average 30 year fixed rate mortgage has inflated as well, from the high 2’s at the end of 2021 into the 4’s as we enter the 3rd month of 2022.

 

When the Fed raises the Fed funds rate, the result is often lower mortgage rates in the near future - along with recession.

When the Fed raises the Fed funds rate, the result is often lower mortgage rates in the near future – along with recession.

Since inflation causes a rise in mortgage rates, it makes sense then that measures to curb inflation would help reduce mortgage rates, and this is often seen when the Fed hikes their Fed funds rate.  We often (not always since several factors play into mortgage bond prices) see mortgage rates go DOWN when the Fed funds rate goes UP.
So the Fed funds rate doesn’t impact consumers?  Not so fast!  While the Fed funds rate doesn’t directly correlate with mortgage rates, it DOES impact many households directly, because the PRIME rate IS tied to the Fed funds rate, and moves in direct proportion.  And since many variable rate products (eg credit cards, home equity lines of credit) are tied to prime, when the Fed raises rates, these products get more expensive.
One final takeaway from the Fed’s rate increase is that due to consumer debt on things like credit cards getting more expensive, and borrowing overall becoming more expensive, the Fed walks a fine line – increasing the rate can put a halt on inflation, but it comes at the expense of economic activity – when the broader economy has access to cheaper money, it’s easier to grow & expand.  As borrowing costs go up, growth becomes more expensive, so increases to the Fed funds rate tend to be a warning sign for pending recession.  This is very likely why the Fed will initially raise rates just .25 rather than a more aggressive .5 increase.  With inflation as high as it is, .5 would be more prudent to reign it in, but .5 would also be a shock to the system that could trigger near immediate recession.  Easing into heightened rates gives the market time to react and adjust.

 

So in the coming weeks, will the Fed be raising rates?  Yes – the Fed funds rate.  Credit card rates, and home equity line of credit rates.  But mortgage rates?  No.  Be wary of any headlines, posts, or advertisements stating otherwise.

John Meussner | MLO NMLS 138061

Licensed by The Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act. NMLS# 1141
MasonMac Corporate

Mason-McDuffie Mortgage

Office: (949) 247-7530

12647 Alcosta Blvd
Suite 300
San Ramon, CA 94583

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