The 0.25% Fed Rate Increase Doesn’t Mean Mortgage Rates Will Increase 0.25%

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Just because the Fed rate went up 0.25% in June does NOT mean the 30-year fixed-rate mortgage rate will go up 0.25%.

The Federal Reserve increased the federal funds rate (Fed rate) last month and currently many expect they’ll increase the rate another 0.5% by the end of the year.

I suspect when most home buyers see a headline that says, “The Fed raised interest rates 0.25%,” they think the 30-year mortgage rate went up 0.25%.

The chart below includes the Fed rate hike last month and going back to 2000. You see a surprisingly weak relationship between the federal funds rate and the 30-year fixed-rate mortgage interest rate.

Fed Rate Versus Mortgage Rate (2000-2018)

See full-size chart.

Certainly, when the Fed rate increases, mortgage rates tend to increase and when the Fed rate falls, mortgage rates tend to fall but it’s loosey goosey.

From the summer of 2004 to the summer of 2006, for example, the federal funds rate increased 4.25 percentage points but the 30-year mortgage rate increased less than 1 percentage point.

Despite the relatively small size of that increase in the 30-year mortgage rate, for those two years, “Interest Rates Increased Again” headlines were constantly in the news which scared the heck out of many home buyers and made the home-buying frenzy worse.

The conventional wisdom at the time was something along the lines of, “We’ll never see mortgage rates this low again, if you don’t buy a home now you may never be able to own a home.” Add that interest rate fear to the panic caused by skyrocketing home prices and home buyers went crazy with FOMO.

Expectations Of Future Rate Increases

Theoretically, higher interest rates are supposed to slow down markets, but in the real world when higher rates cause people to expect even higher rates in the future, the higher rates have the opposite effect in the shorter term. Buyers want to buy now before interest rates increase any more and that causes the market to speed up.

Increasing the Fed rate this week may eventually slow the real estate market a bit, but until then it will most likely make home buyers expect future mortgage rates to be higher and that expectation will make buyers want to buy sooner. More people wanting to buy now puts upward pressure on home prices.

2019

A year from now, however, if the Federal funds rate has been flat for six months, home buyers expectations of future mortgage rates will have also flattened out a bit and that would reduce the urgency home buyers feel to buy as soon as possible.

When people eventually expect flattish mortgage rates in the future, the impact of higher mortgage rates will shine through and the housing market will slow down compared to otherwise.

Right now, however, the impact of people expecting higher mortgages rates in the future is partially or, perhaps, more than completely, offsetting any impact of slightly higher mortgage rates today.

The shorter term effect of a rate increase can be the exact opposite of the longer term effect.

Conclusion

It’s a shame that when the Fed takes action to stabilize the general economy they often destabilize the housing market. Their too-low-for-too-long rates from 2004 to 2006 were a big part of that monster real estate bubble.

It would be nice if the Fed could figure out a way to stabilize the general economy without destabilizing the interest rate sensitive housing market. You know, that market where most American family wealth is located.

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An earlier version of this article appeared in Forbes.com.

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