Mortgage rates fall despite Fed hike
By Holden Lewis, Bankrate.com

When the Fed raises short-term rates, it doesn't necessarily mean that mortgage rates will rise. In fact, they can drop. That's what has happened in the past six weeks.

When the Federal Reserve boosted the federal funds rate a quarter point on June 30, it marked the Fed's first rate increase in four years. The average rate on a 30-year fixed-rate mortgage has dropped almost half a percentage point since then.

The Fed raised the federal funds rate again (by another quarter point) on Aug. 10. Mortgage rates might rise or they might fall in the coming weeks, depending on whether bond investors feel confident or pessimistic about the economy. The Fed's rate policy will have little to do with it.

This week, the benchmark 30-year fixed-rate mortgage fell 11 basis points to 5.91 percent, according to the Bankrate.com national survey of large lenders. That's the lowest it has been since the first week of April, at 5.80 percent. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.31 discount and origination points. One year ago, the mortgage index was 6.37 percent.

The 15-year fixed-rate mortgage fell 12 basis points to 5.30 percent. The one-year adjustable-rate mortgage fell 20 basis points to 4.15 percent.

When the Fed started its latest cycle of rate increases on June 30, moving the federal funds rate up a quarter point to 1.25 percent, the average rate on a 30-year fixed-rate mortgage was 6.30 percent. On July 2, the government released a disappointing employment report for June, and mortgage rates plummeted to 6.08 percent the next week.

Long-term mortgage rates moved up and down in small increments over the next month. Then, on Aug. 6, the government released the second lousy employment report in a row. This one said that the economy created a net 32,000 jobs in July, much less than the 240,000 new jobs that were expected. Treasury yields dropped and so did long-term mortgage rates.

The Fed's short-term rate increase Aug. 10 made little difference because the bond and mortgage markets had known long in advance that the rate hike was coming. Anyway, those markets have been more focused on the overall state of the economy, which doesn't look as good as it did two months ago, and that's why Treasury yields and long-term mortgage rates have fallen over that period.

Since February 1994, the Federal Reserve has initiated three rising-rate cycles. Afterward, sometimes mortgage rates went up and sometimes they didn't.

When the Fed raised the federal funds rate on Feb. 4, 1994, it was the first rate rise in more than four years. In that respect, it was comparable to the June 30 rate increase this year.

Back in February of 1994, mortgage rates jumped substantially across the board in the week after the Fed's action. Rates on 15-year and 30-year fixed mortgages went up 25 basis points. They fell back a bit the next week, before taking another big jump the week after that. The average rate on a one-year adjustable moved up 5 basis points over three weeks.

When the Fed raised rates again on March 22, 1994, rates on 15-year and 30-year mortgages took another big jump. In the two months after that initial Fed rate increase, the average rate on a 30-year mortgage rose 1.46 percentage points. The average one-year ARM went up 73 basis points.

The Fed stopped raising short-term rates in February 1995. Excluding a one-time increase in March 1997, the Fed didn't start another rising-rate cycle until June 30, 1999, when the federal funds rate was raised by a quarter point. Over the following three weeks, the average rate on a 30-year mortgage fell 16 basis points, to 7.56 percent, before abruptly rising.

The 30-year mortgage averaged 7.87 percent when the Fed hiked the federal funds rate for a second time, on Aug. 24, 1999. It oscillated, going down and up and down again in the following weeks. A month after the August Fed rate increase, the average 30-year mortgage rate was 7.82 percent -- down just 5 basis points from four weeks before.

Fast-forward to this year and this rate-hike cycle: Rates on 15-year and 30-year mortgages plunged after the first Fed increase, on June 30, and haven't recovered. Rates on one-year ARMs are slightly down, too. This week's Fed increase has yet to make a difference.

That's not terribly surprising, considering that the Fed has a long way to go. Raising the federal funds rate to 1.5 percent, as the Fed did this week, "is only going to have a minuscule effect anyway, except as a signal," says William Hummer, chief economist for Wayne Hummer Investments. "The availability of credit and capital remains plentiful."

In other words, there's plenty of money to lend, and that keeps rates low.

-- Posted: Aug. 11, 2004