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.

Fed Cuts Rate And Mortgage Interest Rates Rise

I’ve received a lot of calls asking about rates today. Everyone calls and wants to refinance since the Fed lowered the federal funds rate by 0.750%. I patiently tell everyone that the two rates (federal funds rate and mortgage rates) are not directly related. In fact the two are sooooo unrelated that they actually moved in opposite directions today.

As you know yesterday the Fed lowered the federal funds rate by 0.750%. The stock market rallied today in response to this Fed move and was up 300 points (after losing 323 in earlier trading).

Here is what the 30-year rates did today at CTX Mortgage (with 1% origination):

At 9:00 AM: Our rate sheet said 5.250% on purchases
At 1:00 PM: I received re-price notice and the rate jumped to 5.625% on purchases
At 2:47 PM: Another re-price notice and this time the rate jumped to 5.875% on purchases

Notice that as the stock market rallied in response to yesterdays rate cut, mortgage rates got worse. So, why is this? 

At the technical level, when stocks rally, money moves from bonds to stocks and this lowers bond prices and increases yield. Mortgage rates are the yeild on mortgage backed securities (mortgage bonds). At the fundamental level, the Fed move is inflationary. Inflation is the bond markets worst enemy. So, bond prices fall again and increase yield. So, today we saw a double whammy!

I will venture to say that if the Fed lowers short term rates another 0.50% next week (as some expect), 30 year fixed rates will inch higher and higher through the spring and summer of this year. Only time will tell, but if you’re on the fence, now is the time to lock in the rates and move on with your transaction.

Financial Emergency: Fed Cuts Rates by 0.750%

Wow! 0.750% cut in rates. That means the Federal Funds rate is now at 3.50% and prime is at 6.50% (a full 1.750% reduction since September 2007).

This is a complete surprise. The Fed wasn’t going to meet until next week. A rate cut was expected, but with the plunge in global markets yesterday, the Fed comes out with an amazing slash and burn announcement.

Now, is this panic? I think it is. Instead of a cool approach, the Fed has just reacted to something it sees as drastic. Now, if the markets don’t pick up over the long term and the information comes out to be not as alarming as it appears then the Bernanke has a serious credibility issue on his hands. For the short term the Dow has reversed course.

Fundamentally, it is hard to move a multi-trillion dollar economy in the direction of your choice, why government insist on control of this monster I don’t know. I can understand wanting to influence it, but to try to achieve a complete course correction, that to me can only backfire. This is especially true when Washington’s fiscal house is such a mess. With deficit spending, weak exports and a falling dollar, a rate cut can only do so much!

From Yahoo Finance this morning:

WASHINGTON (AP) — The Federal Reserve, confronted with a global stock sell-off fanned by increased fears of a recession, slashed a key interest rate by three-quarters of a percentage point on Tuesday and indicated further rate cuts were likely.

The surprise reduction in the federal funds rate from 4.25 down to 3.5 percent marked the biggest funds rate cut on records going back to 1990.

Only time will tell whether this was a good or bad move, but I don’t like the smell of it!

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