Rate Cut: Federal Reserve Slashes Rates by 0.50%

The Federal Reserve cut the key federal funds rate today by 0.50%. It is now 3.00% (which makes prime = 6.00%).  Here is a brief snippet of what the Fed said today:

Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

The committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

This cut in rates doesn’t mean mortgage interest rates are coming down. Quite to the contrary this move will inevitably move mortgage rates up. This is becuase the Fed move boosts stocks, taking money away from bonds. More importantly this move is inflationary. Inflation is the worst enemy for a long term paper like mortgages. Hence investors (people who buy) mortgage bonds will demand a higher return (hence increased interest rate).

Don’t believe me? Well, last week when the Fed lowered rates by 0.750%, I documented (on this blog) the rise in mortgage rates  the following Thursday. Also, Jay Thompson, at Phoenix Real Estate Guy has stasitical evidence which shows that changes to the federal funds rate by the Federal Reserve does not result in a coresponding change in mortgage interest rates:

In a nutshell, the Federal Reserve controls short term rates (such as the rate that was cut on Tuesday). Mortgage interest rates are not controlled by the Fed, they move up and down based on the trade in mortgage backed securities / the mortgage bond market.

I vaguely remember Dr. Duck (his real name), my undergraduate economics professor, saying something along the lines of the Fed primarily manipulates the Fed Funds rate to control inflationary pressure, provide liquidity to the financial markets and to try to balance employment rates, prices and economic growth.

Care to comment? I’d be happy to hear your thoughts.

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