Hey Federal Reserve! Don't threaten me with a good time.

Recently, there has been a rising amount of chatter about the Federal Reserve System (Commonly referred to as the FED) and interest rates. Jerome Powell, the Chair of the Federal Reserve, recently announced that economic indicators suggest it might be time to start easing the Fed Rate. As of this writing, much of the financial world expects a decrease in the Fed's rate this upcoming September for bank borrowing, which could/should/would help stimulate the housing market (insert fingers crossed emoji).

Here's the reality. Ever since the Covid shutdowns and the changing of the guard at the White House, mortgage rates have, for the most part, steadily increased, peaking in October of 2023 at just under 8%. Compared to the ultra-low rates of just a few years earlier, the cost of borrowing became literally and figuratively too much to bear for many. As a result, there has been a general slowdown in the housing market. Let's look at a few examples of why that is so.

Many current homeowners with rates ranging in the 3 - 4 % area do not want to sell out of their low-interest-rate mortgage/home to buy a new home with a higher rate because the amount of house they are getting per dollar of cost doesn't seem worth it. For example, let's say you financed a purchase or refy in September 2019. Your loan was $300,000. For simplicity, we'll say a 30-year fixed loan. Your payment was in the neighborhood of $1,390 before taxes and insurance. Now, let's say in September of 2023, you wanted to sell your home and buy a new one. A couple of things came into play. First, the interest rate is now 7.75%. And, too, the average prices of homes have risen 67% over those few years. What does that translate to? The same $300,000, 30-year, fixed-rate loan went from $1,390 to $2,150. Couple that with the rising value of homes, and you can see how the prudent choice is most likely to stay put.

What about first-time buyers? Quick math says that the consumer's buying power has been squeezed to the point of incapability. That home, which we discussed in the last paragraph that might have cost $360,000 when purchased in 2019, is now going for $600,000 on average. So, even if you were able to afford that $1,390 payment, the loan would only be for $195,000 or so. Hmmm! You and I both know very few of those homes available these days are equipped with running water and electricity in most areas of the country.

How about new construction? Without going into many details, it is common sense that as interest rates on bank loans go up, fewer companies will take out the loans to do the building. As a result, fewer homes are being built and fewer homes are available for sale to those who need and/or can buy. Which, in turn, drives the prices even higher.

When you put it all together, none of it sounds like much fun.

Which brings me back to the Fed. You might be asking yourself, if keeping rates low stimulates borrowing and helps the housing market, why doesn't the Fed keep rates low? Good question! And I don't know. Just kidding... To understand the why, we need to look at the role of the Fed.

Even though the Fed does not control mortgage rates directly, it influences the rates available to borrowers in the open market. So how does all that take place? Let's look at the relationship between the Federal Reserve System and your basic lender.

Here's how it works:

1. Federal Funds Rate

• What It Is: The federal funds rate is the interest rate banks lend each other overnight. The Fed sets it and serves as a benchmark for different economic interest rates.
• Impact on Mortgage Rates: When the Fed raises the federal funds rate, it becomes more expensive for banks to borrow money. Banks often pass these costs on to consumers by increasing the interest rates on loans, including mortgages. Conversely, when the Fed lowers the rate, mortgage rates usually decrease.

1. Monetary Policy and Economic Outlook

• Monetary Policy: The Fed uses monetary policy tools, such as quantitative easing (buying large amounts of government and mortgage-backed securities), to influence economic conditions. When the Fed buys these securities, demand increases, yields (and interest rates) are lowered, and potentially (another fingers crossed emoji here, please), mortgage rates are lower.
• Economic Outlook: The Fed's view on the economy also impacts mortgage rates. If the Fed is concerned about inflation, it may raise interest rates to cool the economy, leading to higher mortgage rates. If it's focused on stimulating growth, it may lower rates, which could reduce mortgage rates.

1. Inflation Control

• Inflation: The Fed closely monitors inflation and aims to keep it within a target range. High inflation can lead to higher mortgage rates because lenders demand higher rates to compensate for the reduced purchasing power of future payments. If the Fed takes steps to control inflation (e.g., by raising rates), mortgage rates may rise in response.

1. Market Expectations

• Expectations and Sentiment: Mortgage rates are also influenced by what the market expects the Fed to do in the future. If investors believe the Fed will raise rates, mortgage rates may rise in anticipation, even before the Fed acts.

1. Long-Term vs. Short-Term Rates

• Yield Curve: Mortgage rates are typically tied to long-term Treasury yields, which reflect expectations about future economic conditions, inflation, and Fed policy. If the Fed signals that it will keep short-term rates low for an extended period, it can lead to lower long-term rates, including mortgages.

So now that we have more understanding of how the Fed works and its role in the housing market (well, at least I do), let's try to remember one thing. Its primary purpose is keeping the economy moving at a relatively even keel. And as I said in an earlier post, it's all relative to some degree. And for most, this relative has overstayed their welcome.