Fed Hikes Rates. Mortgage Rates Drop. Here's How That Works

For some, this will be old hat.  For others, there’s a mystifying dynamic that demands explanation.  The confusion stems from years of being conditioned to believe that when the Fed “hikes” or “cuts” rates that mortgage rates move accordingly.  That’s actually not exactly how it works. The Fed is currently in a rate hike cycle, so we’ll focus on that.  Today was the latest installment with an as-expected 0.25% increase to the Fed Funds Rate.   There are two important points in that last sentence.  First off, the rate hike was entirely “as-expected.”  That means the market was able to fully prepare for it in advance.  One portion of the market in question is that of mortgage-backed securities (MBS).  These are basically bonds that are guaranteed by pools of mortgage loans.  As investor demand waxes/wanes for those securities, the value of a mortgage changes in the eyes of investors.  This is what determines day to day mortgage rate movement above all else. The Fed only has 8 scheduled meetings to hike/cut rates per year whereas MBS can move as frequently as they want on any given business day.  All that to say that if the market knew the Fed would hike 0.25%, it has long since been baked into MBS prices as well as the rest of the bond market. The second important point is that the Fed deals with the “Fed Funds Rate.”  This is a target range for the shortest-term lending among large financial institutions.  The easiest way to think of it is like the Fed setting the rate of return on a savings account.  The higher it is, the more banks will park money there and the higher rates they must charge other banks and clients to borrow money (otherwise it makes more sense to just park the money in the bank and earn that interest).  
Source: mortgagenewsdaily.comNew feed