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Fed News   Fed announcement: June 24, 2009
  While rates haven't changed, will the Federal Reserve's  
  Open Market Committee use other means to boost the economy?  
How soon will it hit me?

Difficult to predict how rates will move
 

In recent weeks, analysts have been predicting a Halloween treat from the Federal Open Market Committee, or FOMC,

Federal Open Market Committee

The FOMC consists of 12 members: the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year. At these meetings, the committee reviews economic and financial conditions, determines the appropriate stance of monetary policy and assesses the risks to its long-run goals of price stability and sustainable economic growth.
in the form of a 25 basis point cut in the federal funds target rate
Federal funds target rate

The federal funds target rate is the short-term interest rate that banks charge other banks to borrow money overnight from the Federal Reserve System. The actual rate, or effective rate, changes daily and may be above or below the targeted rate. The FOMC sets the rate at its regularly scheduled meetings but may opt to change it between meetings, should economic conditions warrant a change.
. Today, they got it.

How soon could it affect you?
For adjustable rate mortgages, at your next reset.

But are homeowners who now anticipate lower mortgage rates setting themselves up for disappointment?

"It's impossible to know," says Bob Walters, chief economist for Quicken Loans.

There is no easy answer to how -- or even if -- the Fed's rate cut will impact fixed-rate mortgages. Fixed-rate mortgages are tied to the 10-year Treasury or other long-term government bond yields.

As a result, these mortgages are more sensitive to changes in overall economic outlook than to Fed rate changes. Fears about inflation or recession, oil-market volatility and other factors sometimes have a greater impact on long-term rates than the Fed.

In fact, Walters says long-term rates were more likely to change before the Fed announced its decision, as bond traders priced in the likelihood of an October cut. 

"Many times, the market is ahead of the Fed," he says. "The market gets to react every second of every day. The Fed only gets to react eight times a year."

ARM rates would be quite responsive. With ARM rates, you'd probably see it pretty soon.

Usually, long-term rates don't change dramatically after a rate cut unless the Fed's decision surprises the market, Walters says. Because the Fed's quarter-point cut was in line with most expectations, Walters does not expect dramatic changes in mortgage rates. But he admits that it's anybody's guess as to how things actually play out. 

"It's possible they could cut rates and long-term rates could go up," Walters says.

One clue to the direction of mortgage rates might be to tune out the talking heads on financial news programs and instead ask a simple question, he says.

"The Fed just did 'X' -- what did the bond market do?" Walters says. "The hundreds of thousands of people who buy and sell bonds every day control long-term rates."

In particular, he suggests keeping an eye on the 10-year Treasury rate.

"If that falls, it's likely that mortgage rates will fall," he says.

In contrast, the Fed's decision to cut rates by 25 basis points may have a more predictable impact on adjustable-rate mortgages, with rates falling. Most ARMs are tied to short-term indexes. Short-term indexes are highly sensitive to changes in the federal funds rate.

How soon will the rates decline?

"ARM rates would be quite responsive," says Orawin Velz, director of economic forecasting at the Mortgage Bankers Association in Washington, D.C. "With ARM rates, you'd probably see it pretty soon."

Most adjustable rate mortgages are tied to the performance of one of three major indexes: the London Interbank Offered Rate, or LIBOR,

London Interbank Offered Rate (LIBOR)

LIBOR stands for London Interbank Offered Rate. It's the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London. It is a standard financial index used in U.S. capital markets and can be found in The Wall Street Journal. In general, its changes have been smaller than changes in the prime rate. It's an index that is used to set the cost of various variable-rate loans, including credit cards and adjustable-rate mortgages.
the one-year federal Treasury note or the 11th District Cost of Funds Index, or COFI.
11th District Cost of Funds Index (COFI)

Short for Cost of Funds Index. A yield index based upon the cost of funds to savings and loan institutions in the San Francisco Federal Home Loan Bank District. It is one of the indexes commonly used to set the rate of adjustable-rate mortgages.

ARMs tied to LIBOR or one-year Treasuries often react more quickly to a rate cut than ARMs tied to the 11th District Cost of Funds.

Conclusion
If you have an adjustable-rate mortgage, the Fed's decision to cut interest rates by 25 basis points will likely cause your monthly mortgage payment to dip at your next reset. Rates on new fixed-rate mortgages also may dip, but that's much less certain.
-- Posted: Oct. 31, 2007
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