How Interest Rates Can Go Both Ways

The general public is often confused as to how the world works when it comes to economics (the responses to the monthly jobs reports is a good example) but the latest rates cuts by the Fed have the public very confused.

How can it be that mortgage rates (RED) are going up when the Fed has cut the Fed Funds rate by 75 basis points this year?

The simple reason is that the Fed only sets the lending rate or Fed Funds Rate that banks charge each other overnight. (It's a little more complicated than that, but this will suffice. )

And a lot of people don't realize this.

As far as the rates set from that time on, it's the world's bond traders who set the level through price discovery, i.e., what counterparties pay each other for the paper, and right now, those traders are betting that inflation will NOT slow down, and pricing the paper accordingly to their expectations. So, the interest rate for a 30 year fixed conventional mortgage is now back up over 7%, after enjoying a brief dip in the warmer waters of the 6% range. (Most conventional mortgages are priced off the 10 year treasury.)

Naturally, this has a profound effect on the residential housing market.

For commercial real estate, the effect of the Fed cuts is generally beneficial. Many of these loans are set by a fixed "floor rate" with an index added to it. These days, that index is called "SOFR" or the Secured Overnight Financing Rate, which tends to mirror the moves of the Fed Funds in lockstep. So for that that beleaguered sector, buffeted by the pandemic and the Work From Home phenomenon, some relief is in store, especially with a wall of refinancing coming up.

In any case, I hope this explainer puts another myth to rest.