The Federal Funds Rate, Inflation, and the Short-Term Future for Mortgage Rates

The Federal Reserve expects the U.S. economy to grow at a pace of 2.6 to 3.0% in 2015, a “moderate pace” of expansion. The Fed also projects that the unemployment rate will drop to 5.2 to 5.3% in 2015, calling the growth of employment “solid.”

With the U.S. economy seemingly humming along – and with the future looking better and better – the urgent question for the housing industry goes something like this: “will the Fed support an increase in interest rates by raising the federal funds rate off its lowest level for the first time since 2008?”

First, some background.

The Federal Reserve aids the economy with “monetary policy.” One tool that the Fed uses to apply pressure is the “federal funds rate”, which is the interest rate that banks are charged to lend money to one another. In theory, a higher federal funds rate would make banks more reluctant to lend, while a lower interest rate encourages lending.

The Fed has held the federal funds rate at its lowest range since 2008, between 0.00% and 0.25%, in an effort to spur economic growth. This “accommodative monetary policy” is one reason why mortgage rates have dipped to their record low.

The federal funds rate trickles down to consumers, and effects the rate at which we all pay to borrow. Theoretically, a lower federal funds gives banks the ability to lend more money. With more money “supply”, the cost of lending drops.

The Fed can also influence “inflation” using the federal funds rate, and has targeted 2.0% as the healthy target. Even with the accommodative policy, the pace of inflation has been stubbornly resistant to an increase.

All of this is to say: to get a hint about when the Fed will raise the federal funds rate (and interest rates), take a look at inflation. Plummeting oil prices have caused the Fed to downgrade its inflation expectation to a range of 1.0% to 1.6% in 2015, a drop from 1.6% to 1.9% just three months earlier.

With inflation below 2.0%, the Fed says that it will continue to hold the federal funds rate at its lowest level “to support continued progress toward maximum employment and price stability.”

In its meeting statement, the Fed offered vague guidance about how long its stance could last, “It likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time… especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”

In other words, we are not in danger of an imminent rise. But there will be a time (2016?) when the Fed increases the funds rate, and mortgage rates will move up off such a historically low level.


Mortgage Rates

Last week, mortgage rates responded to the Fed’s meeting announcement with a mid-week dip. To begin the Christmas week, rates are slightly higher. Still, over the long term, mortgage rates are right around an 18-month low. With  uncertainty surrounding  slowing global economies, geopolitical turmoil, and (now) falling oil prices, we would expect some measure of stability when it comes to low rates in the near future.

Still, we have seen unexpected jumps in the past. Now is an excellent time to lock. Give us a call at 805.543.LOAN to lock in a low mortgage rate and benefit from the savings offered.