The Federal Reserve: How Does it Affect Mortgage Rates?

Blog posted On March 31, 2023

On March 22, the Fed announced a federal funds rate hike of 0.25%. This move was widely expected by the markets. During the press conference that followed, Fed Chair Powell talked about upcoming tightening due to the recent banking events, which can shape economic momentum. This is the comment the markets honed in on that consequently pushed rate trends lower. Why? Here is how the Fed influences rates.

How the Federal Reserve Influences Interest Rates

While the Federal Reserve doesn’t directly set mortgage rates, its actions can affect rate trends. The Federal Reserve sets the range of the federal funds rate. This rate sets borrowing costs for short-term loans and is the target interest rate for banks and depository institutions. One of the ways the Fed uses the benchmark rate is to help stabilize the economy and flows of money. In times of economic hardship (like the pandemic) the Fed might lower this rate to help boost the economy. In times of high inflation, the Fed might raise this rate to help cool consumer spending. In addition to setting the federal funds rate, the Fed regulates and sets monetary policies. One of the ways it regulates monetary policies is by buying or selling debt securities (like mortgage-backed securities). This helps support the flow of credit, which can push mortgage rates lower.

Do Mortgage Rates Follow the Federal Funds Rate?

Mortgage rates don’t directly follow the federal funds rate. They follow the trajectory and trends of the 10-year Treasury rate. When that rate rises, rates rise. When it falls, rates typically fall. Mortgage rates have an inverse relationship to mortgage-backed securities (MBS). When MBS rise, rates tend to fall.

Other Factors That Are Influencing Mortgage Rates

  • Inflation levels
    • High inflation = bad for bond market = bad for rates
    • Inflation was at a 40-year high last year, and the 10-year Treasury yield surged much higher
    • Inflation & jobs reports were above expectations in February which is why rates were trending higher that month
    • The following report was in line with expectations which was good for rates
  • Economic conditions
    • Things like geopolitical uncertainty (the beginning of the pandemic, Ukraine invasion last year, the banking and credit concerns) topically cause rates to trend lower
    • Tightening the areas that are vital to growth and inflation (banking, credit, etc) will likely put downward pressure inflation levels and rates
  • Secondary market – mortgage backed securities
    • When investor demand is high for MBS, mortgage rates trend a little lower
    • When investors aren’t buying, rates can rise


Source: Bankrate