In June, the Federal Reserve launched its first monetary tightening campaign in years.
By the end of November, the Fed had raised its target interest rate four times and,
through their comments, Fed officials have set the expectation that further increases
will come in 2005.
With that news, you're probably expecting to see mortgage rates up as well over the
past several months. But rates on the most popular mortgage loans have decreased by
more than a half of a percentage point. In mid-June, rates on 30-year fixed-rate,
conforming mortgages averaged 6.32% (with loan fees of 0.5 points). Five months later,
in mid-November, they stood at 5.74% (0.6 points).
In dollars, the decrease in mortgage rates means a monthly principal and interest
payment that's $56 less ($930 vs. $874) on a $150,000 mortgage. Rates on 1-year
adjustable-rate mortgages, meanwhile, have shown little net change, averaging 4.13%
(0.7 points) then and 4.17% (0.7 points) now.
Why the divergence?
First, interest rates don't always move together. And that's particularly true of
rates on short-term instruments versus those on long-term instruments (such as 30-year
fixed-rate mortgages). The Fed's monetary policy actions have a stronger and more
immediate effect on short-term rates.
Second, while current inflation (the rise in general prices you see today) has
gotten a bit worse recently, inflationary expectations (the increase in general
prices you expect to see tomorrow) have not changed much. Financial markets
believe that today's rapid increase in energy prices will be a short-term problem
and that the Fed will appropriately adjust monetary policy to prevent a damaging
cycle of rising inflation. Because long-term interest rates include some estimate
of long-term inflation, the sanguine view of future inflation means that rates on
30-year mortgages haven't increased.
Should the long-term inflation picture deteriorate, however, and the financial
markets lose faith in the Fed's ability to fight inflation, then long-term rates
will rise.
What will foreign investors do?
Among other important factors influencing mortgage rates, such as economic growth
and the soundness of the mortgage markets, is the international financial markets.
The U.S. has become a heavy borrower over the past several years, becoming
dependent on foreign savers to finance our spending, government deficits, business
investments, and even our mortgages. If that should change � if international
investors expect better returns for their funds outside of the U.S. � then U.S.
interest rates would have to rise (everything else being equal).
For example, a homebuyer in Cincinnati wanting a $150,000 mortgage has to compete
with other potential uses of the funds across the globe. If investors believe that
they can earn better returns (given the risks) elsewhere, the borrower basically
will have to pay a higher interest rate to secure the funding. And so those
expecting to buy or refinance their homes will be affected by global financial
changes.
It's difficult to know, of course, which way international markets will go, and
how quickly. But many commentators are concerned that the recent decline in the
dollar's foreign exchange value may be the beginning of a significant adjustment
in global financial markets, which will lead to higher U.S. interest rates in 2005.
