The Federal Reserve is the only government agency commissioned by Congress to act as the central bank of the nation and oversee the long-term performance of the economy. The economy is, influenced by the Fed, as the Federal Reserve is called through actions called policy levers. One of the most significant levers of monetary policy is placing the federal funds rate, which has derivative consequences on mortgage rates.
The Federal Reserve has the authority to affect interest rates but not to directly set any rates at the marketplace. Instead, the supply and demand for cash sets mortgage rates in the housing markets. The division of the Federal Reserve Bank in San Francisco specifies that the Fed’s actions to affect interest rates mostly affect short-term and not automatically long-term rates employed for mortgages. The Federal Reserve affects mortgage rates by controlling the quantity of money circulating in the economy, which causes the economic events that impact mortgage rates.
Federal Funds Rate
The federal funds rate is the interest rate banks charge each other to borrow money overnight from their respective reserve accounts with the Federal Reserve. Considering that the Fed doesn’t have the authority directly set interest rates, the federal funds rate is actually a target interest rate for interbank loans. The federal funds rate a part of the price of conducting business. As the price of conducting business changes so do the rates banks charge their customers as banks try to maximize the return on funds.
The choice to modify the federal funds rate is based on economic information shared by Fed’s decision wing , the Federal Open Market Committee (FOMC). The FOMC meets at regular intervals during the year to assess the health of the national economy and analyze the most recent regional, national and international financial data. From this foundation, the FOMC decides to increase the federal funds rate to control inflation, reduce the speed to encourage growth or leave the rate unchanged.
Higher Target Rate
Any change in the federal funds rate is transmitted through the trading desk at the Federal Reserve Bank of New York. Once the Federal Reserve arrives at a consensus regarding the prospects of the economy, the target federal funds rate is transmitted to the economy by selling or purchasing U.S. Treasury bonds. If the Federal Reserve wants to increase the federal funds target rate, the New York trading desk is arranged to purchase Treasury bonds to lower the money supply. Less cash makes borrowing more expensive. As a result, homeowners face the possibility of paying more of the long-term expense of financing a home.
Lower Target Rate
In the event the Federal Reserve decides that the economy requires a boost to encourage growth, the federal funds target rate is diminished. The New York trading desk is arranged instead to market U.S. Treasury bonds to increase the money circulating in the economy. A bigger money supply makes borrowing cheaper and interest levels are pushed reduced. The benefit for prospective homeowners is a speed, which makes the price of a mortgage cheaper.