When it comes to interest rates, the Federal Reserve is fairly irrelevant. All it does is adjust its rates to those set by the market. If you plot the yield on T-bills against the discount rate, you will see that the former leads the latter. Despite all the rhetoric about it, the Fed has not kept rates artificially low, just as it did not make them soar in the 1970s. The market sets the rates, and the Fed follows.
So when people contact me to say, “I hear the Fed is going to drop rates”, you can understand why I cringe. I simply say that I am not sure we’ll get much help from the Fed and that the Fed does not “control” mortgage rates. They control the “Fed Funds Rate” and the “Discount Rate”, both of which are short term lending rates. These short term lending rates do have “some” effect on long term rates like mortgage rates, but these moves do not “control” mortgage rates.
The media really does a poor job explaining this when they reporting about the “Federal Reserve lowering interest rates!” But, the Fed is a laggard to long term mortgage rates, not a controller or predictor. If the Fed controlled rates, they could make them whatever they want. They could make mortgage rates 3% and ignite a real estate boom to mop up all the foreclosures and excess inventory! But they don’t, because they can’t. Anyone disagree?
Tags: federal reserve
