November 4th, 2018 7:33 PM by Jackie A. Graves, President
There can be some confusion in the minds of the average consumer
about interest rates, especially as it relates to the Federal Open Market
Committee, or FOMC, meetings. About every six weeks, the FOMC meets to discuss
the current state of the economy with an eye toward the future. One important
task is to monitor and adjust the cost of funds. In general, the “Fed” tries to
keep inflation in check and in theory raise or lower the cost of funds. They do
so by adjusting the Federal Funds rate and this is the rate that gets so much
press each time the FOMC meets.
The Federal Funds rate is the rate banks can charge one another
for short term lending. Short term as in overnight. Why does a bank need to
borrow money on such a short notice? Banks are required to keep a certain
amount of liquid capital, in other words “cash,” at the end of each business
day. These funds are essentially demand funds. When a consumer wants to
withdraw some cash either at the bank or at any automated teller, there needs
to be cash available to meet those withdrawal requests. If the bank sees their
reserves to meet these requests do not meet the reserve requirements, banks
seek out a short term loan from another depository institution to meet the
reserve requirements. This is what the Fed adjusts, the overnight lending rate.
But the Fed doesn’t directly impact the everyday 30 year conforming fixed rate
When lenders set their rates each day, they refer to a specific
mortgage bond. For example, with a 30 year fixed conforming loan underwritten
to Fannie Mae standards, the lender will review the current yield on the FNMA
30-yr 3.0 mortgage bond. Just like any bond, with the price of the bond
goes up, the yield will fall. And when the price goes down, the yield will
rise. Investors buy bonds, all types of bonds, as a safe place to park cash.
When the economy appears to falter, investors can get a little skittish and
pull some funds from the stock market and transfer those funds into bonds,
including mortgage bonds. If on the other hand the economy is healthy and
improving, the opposite will occur.
When the Fed makes an announcement at the end of their two-day
meetings, investors are anxious to hear if the Fed raised, lowered or kept
rates the same. If the Fed announces they decided to raise the cost of funds by
0.25%, it can tell investors the FOMC decided the economy is doing rather well
but to hold of any potential inflation, it will raise the cost of funds that
banks will pay for short term lending. It’s not a direct affect on mortgage
rates, but definitely an indirect one.
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