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Rates are at a 5 Month High, But Will They Stay There?

November 7, 2016


A quick glance at the yield on the 10-yield U.S. Treasury note offers a clear picture.

The yield on the 10-year note continually hovers above 1.8% these days. Because the 10-year note influences mortgage-backed securities, which, in turn, influence mortgage rates, mortgage rates also hover at a higher level these days.

Of course, we all know why mortgage rates hover higher – the Federal Reserve. Fed officials want to raise the federal funds rate before the end of the year. After their meeting this past Wednesday, where officials declined to raise rates, they basically have one shot left: the last scheduled meeting of the year on December 14. Most everyone, and we include ourselves, believes a rate increase will emerge from the December 14 meeting.

Does this mean that after the Fed raises the fed funds rate that mortgage rates will hover even higher? If we could offer only a simple answer; unfortunately, the answer isn’t simple.

When the Fed raises the fed funds rate, an overnight lending rate among large commercial banks, it’s really raising only the range. It does this through a couple mechanisms: It raises the rate it pays on required and excess reserves banks held at the Fed.

The rate the Fed pays on deposits strongly influences the fed funds rate. Banks won’t lend to each other at a rate lower than what the Fed pays on deposits. Why lend to your brother when you can lend to your father who will pay a higher rate?

The fed funds rate is a very short-term rate, but this short-term rate serves as a base rate for all other rates. That said, it doesn’t necessarily follow that all rates will rise if the base rate rises. The supply/demand dynamic for loanable funds plays a role. The Fed may raise the base rate, but it’s not mandatory that all other rates rise accordingly. Mortgage rates aren’t forced to follow suit.

Last year, mortgage rates (and the yield on the 10-year Treasury note) trended higher while anticipating a fed-funds-rate increase. When the rate increase occurred, mortgage rates initially trended higher, but they were soon trending lower. The fed funds rate was higher, but long-term rates were again down to pre-rate-increase levels.

Keep in mind, too, that market participants anticipating an event moves markets more than the actual event. We wouldn’t be surprised if mortgage rates crept higher this month and then reversed course as December approaches. Of course, our prognostication comes with a caveat: There are no guarantees.  

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