The Federal Reserve, often referred to as the Fed, recently raised short-term interest rates 0.25% (25 basis points) at its most recent Federal Open Market Committee (FOMC) meeting, after telegraphing its intention for some time. All homebuyers fear rising interest rates since that means an increased mortgage payment every month, all else being equal. We examine the process and see if these worries are overblown.
The central bank’s role
The Federal Reserve Bank is the central bank of the United States. Without getting into all the functions it performs, one of its main ones is to set monetary policy. Seven members of the Board of Governors and five presidents sit on the FOMC, which set short-term interest rates.
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Previously, under the Alan Greenspan Fed, the central bank spoke with one voice. However, under his successors Ben Bernanke and current Chairwoman Janet Yellen, that is less true. Reading the tea leaves has become more challenging, with some members recently advocating for tightening the spigot (raising interest rates) earlier than December. However, Chairwoman Yellen’s recent comments signaled a clear intent to boost short-term rates at the latest meeting.
The Federal Reserve examines mountains of data and does a lot of research to determine the appropriate monetary policy. Strengthening economic data has reinforced the argument for raising rates this month, including third quarter GDP growth of 3.2%, as the Fed seeks to keep a lid on inflation before it heats up.
Impact on mortgage rates
The most popular type of mortgage to obtain is the 30 years fixed rate. Examining fixed rate mortgages, it is more important to look at longer-term Treasury rates, such as the 10-year note. The Fed has a direct impact on shorter-term rates, which can be seen by examining yields on the 2 year Treasury. Traditionally, it has less of an influence on longer-term rates. Following the 25 basis point hike in rates, the 2 year Treasury yield rose to 1.29% compared to 1.17% before the meeting. The 10-year yield went up a much smaller amount, to 2.54% versus 2.49%.
However, following the election, the 10-year yield has been climbing. This is due to fears inflation could heat up, particularly if President-elect Trump’s fiscal plan, including large tax cuts and infrastructure spending, becomes a reality. The yield on the 10-year note was under 2% before election day results were known, at 1.88% on November 8th. It has jumped subsequently and is currently 2.6%.
What to watch
There is not much you can do about interest rates, other than locking in a fixed rate, typically for 10 to 60 days. Buyers usually wait until his/her offer has been accepted before doing so.
You should monitor the Fed and longer-term rates in order to keep abreast on rate, however. Keep an ear out for economic data that shows a strengthening economy that might portend higher inflation. In particular, the headline Consumer Price Index (CPI) rose 0.2% in November, and 1.7% over the last 12 months. This is higher than the 0.8% figure reported in July. The Fed’s preferred inflation gauge, the personal consumption expenditure (PCE) showed a 0.1% increase in October, the latest figure available, and 1.4% over the last year. These figures will also be presented after stripping out food and energy, which tend to be volatile from month to month.
Mortgages rates may have moved up recently, but remain low by historical standards. According to Freddie Mac, the average 30-year rate was 3.77% (0.5 points, or upfront interest), the highest monthly average since January. However, it was over 4% for much of 2014, and a 7% rate was common in 2001. Rates were even higher going back further.
Should rates continue to increase, this could crimp housing demand. Prices will fall as a result, which is beneficial to the buyer.