The Fed Doesn’t Dictate Mortgage Rates

Ruben Gonzalez, Keller Williams Chief Economist|Published: Jul. 9 2019

Mortgage rates have dropped since late last year, and that’s good news for consumers. Lower rates mean consumers pay less over the life of their home loan.

For agents, taking the time to understand how mortgage rates work is key. As you guide your clients through the homebuying or selling process, it’s a tool you can use to drive informed conversations and help them better weigh their options.

So, what’s important to know about mortgage rates? First off, let’s talk about a common myth out there, that the Federal Reserve, also referred to as “The Fed,” sets mortgage rates. That’s not entirely true.

What’s the Federal Reserve?

It’s the central bank of the United States, and it controls our money supply. If you think about the U.S. economy as a person, money is the blood, the banking system is the heart, and the Fed is our cardiologist. Congress has tasked the Fed with keeping tabs on two of our vital signs – inflation (how fast prices go up) and employment, specifically keeping the economy at the maximum level sustainable.

The Fed keeps its eye on that big picture. When Fed members meet eight times a year to talk about how the economy is doing, they’re not specifically setting mortgage rates. Instead, they’re deciding how to manage the supply of money in circulation. They do this by buying and selling short-term Treasury bills. 

Here’s how the Fed operates.

If it thinks the economy is sluggish, it will buy Treasurys, thereby injecting cash into the economy. In response to the increased demand for Treasurys created by the Fed, their price goes up and their yield, or their rate of return, goes down. When that rate is low, it’s cheaper to borrow money, so consumers and companies spend more. That boosts the economy.

On the other hand, if the Fed thinks prices are beginning to grow too rapidly, they will start selling off the Treasurys on their balance sheet in an effort to reduce the supply of money circulating in the country. Less demand means lower prices for the bonds and their rate goes down. Higher rates mean people are less likely to take out loans and spend. The goal is to keep prices in check without slowing the economy down too much and creating a recession.

Mortgage rates are very much tied to Treasury yields, but here’s the rub.

They aren’t the same Treasurys that the Fed normally buys and sells to manage the money supply. The Fed uses short-term Treasurys while mortgage rates track with longer-termed Treasurys that are assets much more comparable to a mortgage. That’s why mortgage rates don’t always move in lockstep with Federal Reserve policies. The best proxy for mortgage rates is generally the 10-year Treasury, and because these bonds span a bigger chunk of time, their prices are impacted by more than just what the Fed is doing.

Long-term Treasury rates are impacted by a lot of things, ranging from people’s expectations about the future health of the US economy to global, geopolitical events. When people think things are risky in the world, you will often see money move into these bonds and drive down their rates.

The trick to learning and following mortgage rate movements is often to read the news and look at how yields on 10-year Treasury rates respond. Often, you’ll find that within a week mortgage rates will follow changes in the 10-year Treasury almost to a tee.

So, what does all this mean for real estate agents?

All other things being equal, we know that when mortgage rates go up, home sales go down. And when mortgage rates fall, home sales should go up. All other things are rarely equal, but that doesn’t mean you can’t use this information to create valuable insights about the direction of mortgage rates and home sales in your market. You can have better conversations with your clients and demonstrate your value, not only as an expert on the local market, but as someone who can see the big picture.

About Ruben Gonzalez

Ruben Gonzalez is the chief economist at Keller Williams. He leads in-depth research efforts and tracks leading indicators that impact the housing market.

Gonzalez creates ongoing housing forecasts and regularly provides commentary on real estate market trends to a range of national business, real estate and financial news outlets.

Gonzalez received his undergraduate degree and earned his master’s degree in economics from The University of Texas at Austin.

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