News Flash: Federal Reserve Makes Dramatic Interest Rate Cut (Again)
In the latest move to both stabilize financial markets and shore up a flagging economy, Ben Bernanke and the Federal Reserve took dramatic action on March 18th, cutting interest rates by 0.75%.
This move is part of a growing patchwork quilt of government economic initiatives which have emerged since year-end. That quilt includes:
- Three separate Federal Reserve rate cuts
- A sweeping tax rebate program
- Extraordinary measures to provide liquidity to financial institutions
The maddening thing about economic policy moves is that it will take months to know how they will pan out. However, while Washington and the heartland wait to see what the results of these stimulative measures will be, one group that should not be waiting is mortgage shoppers. For anyone looking to refinance, and especially for prospective home buyers, the best time to act might be the present.
The Long and the Short of It: Why Some Interest Rates Act Differently from Others
With the Federal Reserve having lowered interest rates so aggressively, it might be a natural reaction to wait for mortgage rates to follow suit. After all, the widely-quoted Federal Reserve rate is now 2.25%, while thirty-year mortgage rates are still in the neighborhood of 6%.
However, it is important to remember that long-term and short-term interest rates behave very differently. For one thing, the Federal Reserve can directly control its short-term rate, whereas long rates are set by the marketplace. Thus, while the Federal Reserve may drive short rates unnaturally low for policy reasons, long rates cannot be made to follow.
Another difference between short-term and long-term rates is that because of their different lending periods, they represent a different perspective on economic conditions. In economics, long periods tend to smooth out extremes, so short-term rates are more likely to change dramatically than long-term rates. This is why long-rates, like thirty-year mortgage rates, will often appear relatively unmoved by large swings up and down in the Federal Reserve rate.
Three Reasons to Like Current Mortgage Rates
While there is little reason to expect mortgage rates to follow the full extent of the Federal Reserve’s 0.75% rate cut, there are three reasons to like mortgage rates right where they are:
- They are near the lower end of an historical range which has seen them go as high as 18.45%, but no lower than 5.23%
- With inflation running at around 4% per year, there is a natural floor preventing mortgage rates from going much lower unless inflation eases
- If the Federal Reserve is successful in stimulating the economy, rates are more likely to turn upward than downward
Watching Out for Intended and Unintended Consequences
All actions can have intended and unintended consequences, and in the case of the Federal Reserve’s interest rate cut, either way there is a strong argument for starting to shop for a mortgage now. As noted above, if the Fed stimulates the economy, a cyclical upswing in interest rates — and housing prices — could follow. The unintended consequence of the Fed’s action could be a worsening of the inflation picture, and that also would drive rates up. In short, mortgage rates won’t see the dramatic drops that Fed rates have, but they are a pretty good deal where they are now.
Tags: Bernanke, fed, Federal Reserve, interest rates, mortgage, mortgage rates, refinance, short-term interest rates
