https://www.financialsamurai.com/why-are-mortgage-rates-falling-after-the-fed-started-raising-interest-rates/
Between 2H2018 and 1H2019, something funny happened. The Federal Reserve was raising their Fed Funds rate, yet mortgage rates kept on falling. This article explains why are mortgage rates falling after the Fed starts raising rates. Hint: The Fed is not always right.
Even though the Fed has slashed rates to 0% – 0.125% due to the pandemic, let’s study what happened in the past. Today, the Fed is aggressively raising the Fed Funds rate to combat elevated inflation.
Despite the Fed raising interest rates methodically since late 2015, mortgage rates have actually gone nowhere during this time period.
First, let’s look at the Fed Funds rate chart since end of 2015. The hikes have been steady and quite steep based on where we came from.
Now let’s look at various mortgage rate terms since 2015. Notice how the average mortgage rates for a 30-year fixed, 5/1 ARM and 15-year fixed are all back to where they were at the end of 2015.
Why aren’t mortgage rates increasing along with the rise in the Fed Funds rate?
The simple answer is that the Fed does not control mortgage rates. The bond market via bond investors do.
The Federal Reserve sets the overnight lending rate (Fed funds rate), which determines how expensive it is for banks to lend money to each other on overnight transactions.
This short-term rate helps determine money market rates, checking account rates, short-term CD rates, and even egregious credit card rates. For example, you can now get a healthy money market rate whereas back in 2015, the best you could do was around 0.25%.
Mortgage rates, on the other hand, are influenced by the 10-year US Treasury bond, which is determined by the market, not the Fed.
On the one hand, low bond yields mean that the opportunity cost for not holding bonds is low. Therefore, investors are more inclined to invest in stocks, especially if the S&P 500 dividend yield is higher than the 10-year Treasury bond yield.
Just imagine if the 10-year Treasury bond yielded 10%. You may not be inclined to risk as much money in the stock market because the 10% is a guaranteed annual return if you hold the 10-year bond to maturity.
That said, if the 10-year bond yield is at 10%, it likely means there is rampant inflation due to massive wage pressure and accelerated corporate earnings. In this scenario, stocks may very well return much greater than a risk-adjusted 10% a year.
Declining mortgage rates also means more people can afford homes. The real estate market is unlikely to collapse under a wave of mortgage defaults because the credit quality of mortgage borrowers has drastically increased since the financial crisis.
The average FICO score for an approved mortgage is over 720, and you no longer have NINJA loans that don’t require any money down. Those adjustable rate mortgages that are resetting today aren’t going to see a large uptick at all.