The Federal Reserve lifted the federal funds rate last month by a quarter percentage point to a range of 1.75 percent to 2 percent. The Fed has indicated that there will most likely be two more rate hikes this year.
Mortgage interest rates don’t necessarily move in step with the federal funds rate, as they are more closely tied to the 10-year Treasury Bond. So, borrowers today looking to get a mortgage aren’t directly affected by the latest Fed hike.
However, the federal funds rate does contribute to the longer-term trends of the 10-year Treasury, and long-term fixed mortgages as a result.
With the Fed likely lifting rates multiple times over the next couple of years, the trend for long-term mortgage rates is up.
Why is the Federal Reserve raising rates?
Well, it’s a bit complicated, but there are some very good reasons – and they are all designed to help foster stable, economic growth.
Between 2009 and 2014, the US Federal Reserve created $3.5 trillion during three phases of what was called “Quantitative Easing”. It was the Federal Reserve’s response to help reduce the dramatic market swings created by the recession about 10 years ago.
This seems to have helped the economy avert disaster, but their impacts were far from ideal. Nonetheless, the economy slowly lifted off as consumers rebuilt their balance sheets and asset values rose.
Today, the Fed is slowly reversing this stimulus program. They’re raising short-term rates and shrinking their bond and mortgage back securities portfolio.
The consensus thinking is that the Federal Reserve members fear that inflation will take hold if they keep interest rates artificially low.
Historically, when the bonds owned by the Fed mature, they simply reinvested the proceeds into new bonds. It essentially keeps the size of the balance sheet stable, while having very little impact on the market.
However, when quantitative tightening began in October of 2017, the Fed started slowing down these reinvestments, allowing its balance sheet to gradually shrink.
In theory, through unwinding its balance sheet slowly by just allowing the bonds it owns to mature, the Fed can attempt to mitigate the fear of what might happen to yields if it was to ever try and sell such a large amount of bonds directly.
Essentially, the Federal Reserve is changing the supply and demand curve and the result is a higher yield in the 10-year treasury note.
Inflation and Interest Rates
Inflation is beginning to inch up as the labor market continues to improve. Most indicators suggest inflation has been climbing in recent months. If you look at both the Producer Price Index and the Consumer Price Index, you will see the trends.
This is a general reflection better economic data, rising energy prices, and increased employment.
Rising inflation is a threat to government bond investors because it chips away at the purchasing power of their fixed interest payments. As mentioned earlier, the 10-year Treasury yield is watched particularly closely because it is a bedrock of global finance. It is key in influencing borrowing rates for consumers, businesses and state and local governments.
Positive labor and economic news keeps coming in (as predicted over the last 6 months), and the prospect of inflation will put pressure on bonds and interest rates.
What It All Means
So, it is safe to say that we will continue to see pressures in the bond market and mortgage interest rates overall. These increases do look to be gradual for the time being, but consistent and into 2019, for sure.
With that said, home prices are increasing nationally at nearly 6%, so the increase in interest rate will be more than offset by the increasing value of one’s home!
Secondly, home buying power is still extraordinarily high, despite rising home prices and rate hikes. Find out more about that here.
In reality, now is a fantastic time to purchase. Contact me for more information, as it would by my privilege to help you.