WHAT DOES IT MEAN WHEN FED FUND RATE GOES TO ZERO?

By: Jasama Patel jas@jasamapatelloans.com, 650-438-2133.

The Feds announced slashing interest rates to zero so what does this mean for mortgage rates?
The Feds cut the Fed Funds rate which is a short term lending rate that banks charge other banks for overnight lending. Banks have to keep a certain percentage of reserves and when they fall below that percentage they then borrow from another bank to meet that reserve requirement.
Banks use their reserves to make money from credit cards, auto loans, business loans, home equity lines of credit, etc. so thus if money is cheaper to get for them then so are the rates on these types of credit to you the consumer.
Mortgage rates are basically determined by how mortgage backed securities perform. The more that is bought by investors the lower mortgage rates go (higher supply). The more that is sold by investors the higher mortgage rates go (less supply).
So as you can see when the Feds lower “rates” they are not directly lowering mortgage rates since they’re entirely separate otherwise you’d see mortgage rates at zero percent!!
So what then makes mortgage rates go up/down?
As stated above, mortgage backed securities are bought and sold by investors on Wall Street just like all other investments and so the more that is bought the lower rates go and the more that is sold the higher rates go.
Mortgage backed securities are “fixed investments” and are more stable and deemed a “safe haven” just like other fixed investments like treasuries and bonds with those 2 backed by the US government. So in times of uncertainty and volatility these types of investments are bought. Stocks on the other hand are just the opposite as they are riskier but with risk can also mean a higher return so in good times and when the economy is humming along then stocks take off and generally fixed investments go the other way.
Feds lower interest rates (remember not mortgage rates) when there is uncertainty and the prospect of a slowing economy and/or possible recession which of course are the SAME reasons why investors buy treasuries, bonds and yes mortgage backed securities so this is why most times they go hand in hand (lower rates across the board) BUT and this is VERY important to note that they don’t mirror each other in terms rate (if Feds lower rates .50% this doesn’t mean mortgage rates go down .50% and if the Feds lower rates to zero this doesn’t mean mortgage rates go down to zero!
Inflation is a big key as the lower inflation is or forecast to be then the more valuable it is for an investor who buys treasuries, bonds and mortgage backed securities since these are all fixed investments and if tame and/or lower inflation then their return is higher.
Higher Inflation or forecast to be higher then this tends to make fixed investments including mortgage rates go up because inflation “eats” into their fixed investment.
Now this might sound weird but the more the Feds lower rates eventually mortgage rates go higher along with other fixed investments because this is done to spur a slowing economy and if the economy gets hotter than “generally” this means inflation picks up.
Now, right now this market has been one of the most confusing and volatile in years where mortgage rates have gone up despite stocks tanking and inflation tame but a lot of this has to do with lender capacity, quick refinance prepays and bank liquidity.