By Rayna Penelova
As the Fed raised rates by a quarter point to 0.75%, many Americans assumed that mortgage rates would follow suit. On the surface, that makes intuitive sense. However, the 30-year mortgage rate fell by almost a quarter of a point over the next several days. After fielding questions from puzzled friends and family members, I thought this would be a good topic to tackle in my next blog post.
Rather than being determined by the Fed Funds rate, mortgage rates are driven by the 10-year treasury yield. In fact, the relationship between the 30-year mortgage rate and the 10-year treasury yield is rock solid with a 94% correlation. The graphic below shows how similarly they track over time.
Longer-term rates are driven by market actions. One of the most important factors driving market action is future expectations. When market participants expect the economy to weaken, the demand for treasuries increases as treasuries are considered a “safe haven” asset. Greater demand leads to higher prices, which in the world of bonds means lower rates. Inflation is also an important consideration. When inflation is expected to accelerate, bond investors demand higher compensation, as inflation will eat away at the value of their investment. As a result, higher inflation tends to lead to higher rates. Other factors, such as foreigners buying our bonds also impact the 10-year treasury rate. Yes, the Fed Funds rate is the base component of long-term rates, but there are other considerations that the market must factor in when pricing bonds.
So, next time the Fed raises rates, take a look at the 10-year Treasury rate before you get worried about the cost of that mortgage you’re about to lock in. It may not be as bad as you think. Of course, it could also be much worse.
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