What drives Mortgage Rates – and no it’s not the Federal Reserve

I am always astonished by the number of reports I read, before and after the Federal Reserve (Fed) makes a change in its interest rate, about the effect such a change will have on mortgage rates.
No doubt it came as a surprise to those writers when there was virtually no change in the Freddie Mac weekly survey of mortgage rates this week.

Myth
“Mortgage rates react to the Fed.”
Look at this chart for the last year:

The FFR rate was unchanged at 5.5% for over a year until last week, but during that time frame the FRM varied between a high of almost 7.8% last October and a low of just over 6% last week before the Fed cut its inetrest rate by 0.5%.(The Freddie Mac survey takes place from Monday-Wednesday each week, so the 6.09% reported on September 19 reflected rates before the Fed cut its interest rate).

What happened after the Fed cut rates?
Precious little. The rate before the Fed cut rates was 6.09% and afterwards…. 6.08%.

In simple terms, there is no correlation or link between the Fed’s interest rates and the rate on 30-year Fixed Rate Mortgages.

What does determine Mortgage Rates?
Take a look at this chart which compares the FRM with the yield on the 10-year Treasury note (10T).

Note that the two charts follow each other closely.

Why do Mortgage Rates track the yield on the 10-year Treasury?
Most conventional mortgages (i.e.those meeting the terms set by Fannie Mae and Freddie Mac) are sold by the originator to Fannie and Freddie, thereby freeing up the lenders’ capital to make more loans. Exactly why Fannie and Freddie were founded.
And what do Fannie and Freddie do with these loans? They package them into large pools and sell them to investors in the public market as Mortgage-Backed Securities (MBS). Because investors demand a higher yield to buy MBS than they would to buy a Treasury Note – because the risk is higher – they demand a premium – or spread – above the yield they would receive from the Treasury Note with a similar maturity to the expected life of the mortgages – and that is the 10T.

Is the spread consistent?
Good question. The answer is no.
For most of this century the spread was in the 1.6 – 1.8% range and averaged around 1.75%. The exceptions were:
2008 – the Great Recession and the height of the foreclosure crisis making mortgages unattractive to investors, who demanded higher yields
2020 – at the outset of the pandemic, amidst widespread uncertainty, spreads widened before the Fed started its huge program of pouring money into the economy, buying both Treasuries and MBS and igniting an asset boom
2022-23 – when the Fed finally, belatedly, stopped injecting liquidity into the system, the market reacted to two main factors: the Treasury would need to sell a lot more Securities to fund the spending, and the growing Budget deficit; and the biggest buyer of Treasuries – the Fed itself – was switching from being a buyer to a seller.The Fed also continues to hold a huge amount of MBS, which it is slowly reducing by not reinvesting.

Fannie and Freddie have increased fees to lenders
In addition to the fact that the Budget deficit continues to increase, while the Fed has been a seller of Treasuries, Fannie and Freddie have increased the fees they charge to lenders. These two factors have combined to increase the spread to more than the historic 1.6-1.8% , as shown in this chart, again for the last year:

Where are Mortgage Rates headed?
Thw two biggest questions facing the Treasury market are: will Congress take steps to rein in the soaring Budget deficit, and will foreign investors retain their appetite for US securities?
I don’t know, but to know where mortgage rates are headed,the most important number to watch is the yield on the 10-year Treasury Note.

Cheaper Mortgages are available
The Freddie Mac weekly survey is a national report. I work with lenders in both Florida and Massachusetts who are offering 30-year FRM for 5.5%. And other options are as low as 5%. Call me for details.

Recent Market Reports
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Andrew.Oliver@Compass.com

AndrewOliverRealtor.com