Fed rate cuts don’t always spell lower mortgages

Associated Press

Q I’m looking to buy a home and want to get a good mortgage rate. The Federal Reserve has cut its interest rates five times this year and I expected mortgage rates to come down as well, but they haven’t. Why not?

A While the Federal Reserve manages short-term interest rates, it actually has no direct control over long-term rates set by the bond market. Many homebuyers expect long-term mortgages to rise and fall with short-term interest rates, but they don’t always.

“The connection between what the Fed does and mortgage rates is often quite loose,” said Robert Van Order, chief economist for the Federal Home Loan Mortgage Co., better known as Freddie Mac. “There is a long-run tendency for long-term and short-term rates to run together, but in the short run, they can run in the opposite direction.”

Take current mortgage rates. The Fed has slashed short-term interest rates six times, or 2.5 percentage points, since early January, with the most recent cut on May 15. That is the most aggressive credit easing since 1982.

But rates on the 30-year mortgages popular among homeowners haven’t moved that much, and are currently inching upward.

Last week the rate averaged at 7.47 percent, the highest this year after hitting a low of 7.07 percent in March, according to HSH Associates, a financial publisher based in Butler, N.J.

In contrast, from May 2000 until January 2001, the average 30-year mortgage rate plunged from 8.82 percent to 7.31 percent. During that time, the Fed was holding short-term interest rates steady after three rate hikes in early 2000.

What’s happening?

The bond market – and the long-term rates to which 30-year fixed-rate mortgages are linked – are most influenced by prospects for economic growth and inflation. That’s because lenders aren’t interested in getting locked into low rates for a long term if they believe inflation could devalue their money.

In early 2000, mortgage rates jumped as bond traders worried that the booming new economy was moving too fast for its own good. Only after a noticeable slowing in late 2000 did traders accept that inflationary fears were unfounded, leading to a drop in mortgage rates – even before the Fed took action in January.

Now, after the five Fed rate cuts, mortgage rates are edging upward as traders worry once again about a bloated money supply.

“The bond market is now more confident there will be economic expansion and no recession,” Van Order said. “But when people expect the economy to expand, they also expect inflation to go up some.”

So what does this mean for prospective homebuyers?

“There’s no better time than the present,” says Keith Gumbinger, vice president of HSH Associates. “Mortgage rates are more likely to rise than they are to fall as the economy appears to be slowly getting its feet back under it again.”

Although the current 30-year mortgage rate is the highest in 2001, it still remains more than one percentage point lower than this time last year, when the rate stood at 8.65 percent.