Mortgage rates largely unaffected by Fed's cut

The cost of a mortgage, which is affected more by bond prices than the federal funds rate, increased slightly on Tuesday.

By JIM BUCHTA, Star Tribune

Last update: March 19, 2008 - 12:42 AM

Another Fed rate cut -- the sixth since September -- is good news for businesses and borrowers who are looking for a break on their home equity loans and credit cards, but it's unlikely to do much to boost the sagging housing market by making mortgages more affordable.

After Tuesday's Fed announcement, mortgage interest rates did what they rarely do: They rose slightly, to 5.75 percent for a 30-year fixed-rate mortgage, up from 5.5 percent.

That's still near historic lows. But there is some upward pressure on long-term rates in the coming months depending on what happens elsewhere in the economy.

"The Fed can't wave a magic wand here," said Scott Anderson, an economist with Wells Fargo in Minneapolis. "The Fed is trying to ease rate pressures, but again the Fed is fighting against other forces in terms of inflation and growth expectations, which is working against what the Fed is trying to do."

That's because long- and short-term mortgage rates aren't tied directly to the Fed funds rate, which influences the prime rate. So Tuesday's 0.75 percentage point cuts to the short-term federal funds and discount rates (now 2.25 and 2.5 percent, respectively) simply don't translate into lower mortgages rates. Instead, most mortgage rates tend to follow bond prices, which are affected by broader economic forces including the stock market, prospects for economic growth and inflation expectations.

And right now inflation fears rule the bond market. When the Fed lowers the cost of borrowing by lowering the prime rate, spending tends to rise, creating a greater chance of inflation, thus scaring investors out of the bond market. To bring them back, bond prices fall, yields rise and long-term mortgage rates tend to rise commensurately.

It's a balancing act that mortgage brokers are paying close attention to as they try to advise their clients about when it makes sense to lock in a rate. Guessing the market is getting increasingly difficult as competing economic forces challenge previously held assumptions.

"In this credit market anything can happen," said Alex Stenback, with CTX Mortgage in Plymouth and author of a mortgage blog at www. behindthemortgage.com. "Mortgage rates are being buffeted by forces that don't have anything to do with the Fed."

By decreasing the cost of borrowing, the Fed hopes to avert a recession. But the bond markets have already anticipated the Fed's rate reductions and the expectations that the economy could be growing again during the second half of the year, Anderson said.

It's not unusual for long-term mortgage rates to increase in the wake of a Fed rate cut, but it usually takes several days for that to happen. Not this time. Stenback said that during the past five cuts it's taken anywhere from 2 to 12 days to see a 25- to 62-basis-point increase in rates.

And often, short-term rates will fall after a Fed cut. Today, however, investors were disappointed that the cut wasn't deeper, so short-term Treasuries including the benchmark 1-year Treasury, which is tied to the cost of adjustable-rate mortgages, rose slightly.

Wells Fargo economists say that the Fed will stop the cuts at 2 percent by its next meeting, but the futures market suggests the rate cuts will end at 1.75 percent.

"This is dicey business," Anderson said. "The markets have been pricing in a shallow economic recession."

The decline in the Fed's fund rate, however, could benefit people seeking adjustable-rate and jumbo mortgages that are tied to LIBOR, or the London Interbank Offered Rate, which hovered just about 2 percent this week and tends to follow the Fed funds rate.

Stenback said that even if rates fall in the wake of this or subsequent Fed funds-rate cuts, access to credit is tight and down payment and equity requirements are still challenging for many borrowers and various mortgage products.

Jim Buchta • 612-673-7376