The Federal Reserve’s Open Market Committee today continued its course of raising its target for the federal funds rate by .25 percent, bringing it to 2 percent.
The move is the fourth hike in five months, beginning with a 25 basis point hike in June. That was the first time the Fed had raised the rate in four years, and the Fed appears poised for more rate hikes until it reaches what it considers a neutral monetary policy.
Mortgage rates have not followed suit yet, although they could be poised to rise soon. The benchmark 10-year Treasury bond yield has been rising, going to 4.26 percent on a $14 billion U.S. Treasury sale today. Just two weeks ago, the yield hovered below 4 percent.
The Fed changed little in its policy statement from its last meeting, saying it believes that even after today’s hike, its monetary policy remains accommodative. Combined with “robust underlying growth in productivity,” the monetary policy is providing ongoing support to economic activity, according to the Fed’s statement.
“Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved. Inflation and longer-term inflation expectations remain well contained,” the Fed wrote in its only wording change from last time.
The Fed retained wording from previous statements that policy accommodation can be removed “at a pace that is likely to be measured.” It said the committee would respond to changes in economic prospects as needed “to fulfill its obligation to maintain price stability.”
The federal funds target rate is what banks charge each other overnight. It has no direct impact on other rates, such as those for mortgages, but it can alter them indirectly.
A change in the federal funds rate, for example, is likely to change the prime rate, the rate banks charge their best corporate customers. That’s generally about three percentage points above the federal funds rate.
From there, any lines of credit tied to the prime rate rise as well. The yields on short-term Treasury bills generally move with changes in the federal funds rate, which also moves any adjustable-rate mortgages tied to short-term Treasury bills.
Fixed-rate mortgages are more closely aligned with the 10-year Treasury bond, and 30-year fixed rates tend to move closely with them, which is why the recent bond increase could mean rising mortgage rates. The 10-year Treasury bonds tend to reflect what the market is expected to do longer term, as well as anticipated changes in the federal funds target rate.
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Often, the rates now move in anticipation of the Fed announcement itself.
Shortly after the Sept. 21 rate hike, mortgage rates increased slightly. The rate on a 30-year fixed-rate mortgage hit 5.82 percent in early October, but has declined since then to about 5.7 percent last week, according to Freddie Mac’s weekly mortgage market survey.
Most economists have been predicting rates will stay relatively low for the remainder of the year, and rise slightly next year.
David Lereah, chief economist for the National Association of Realtors, said the 30-year fixed-rate mortgage should stay under 6 percent for the rest of this year and then average only 6.5 percent in 2005. That gradual rise will carry the housing market’s momentum well into 2005, he said.
The Mortgage Bankers Association is predicting interest rates will reach about 5.9 percent by the end of 2004.
“We are forecasting only a modest increase in rates despite the continued expansion of the economy,” said Doug Duncan, MBA’s senior vice president and chief economist said recently. “As long as rates remain at these levels, home-buying will remain an attractive alternative to renting, and the purchase market will continue strong.”
MBA’s forecast calls for purchase originations to decline from an expected $1.48 trillion in 2004 to $1.45 trillion in 2005 and $1.44 trillion in 2006.
The forecast also predicts that 30-year fixed-rate mortgages will increase gradually to 6.5 percent by the end of 2005 and 6.8 percent by the end of 2006. That will largely be a result of long-term Treasury rates staying well below 5 percent during 2005 and climbing to 5.1 percent by the end of 2006, according to MBA’s forecast.
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