The Federal Reserve's short-term rate may be on a steady decline, but long-term mortgage rates have been showing a lot of volatility.
Economic uncertainty, jittery lenders and recession fears have done a lot to shake interest rates lately. While there are many wildcards, including what happens with oil prices, inflation and the current housing mess, most economists believe that long-term rates will fluctuate within a point or two of 6 percent throughout 2008.
“Six percent is higher than what we saw a few years ago, but it's still well below average.”
Gus Faucher, an economist with Moody's Economy.com, says that the current recession is likely to carry on throughout the first half of the year and remain relatively mild. By reducing inflation expectations, Faucher expects long-term rates to decline in the near term. He looks at Treasury bill rates for an indication and says he expects 30-year fixed rate mortgages to hover around 6 percent through the first half of the year before slightly increasing as the economy recovers and inflation expectations rise. Faucher says that even if current long-term rates were to rise a bit, they would still be low by historical standards.
"If you look over the past 20 years, rates have been more in the 7 (percent) or 8 percent range. Six percent is higher than what we saw a few years ago, but it's still well below average," says Faucher.
Contrary to what many consumers may think, the Fed's short-term rate has little impact on long-term mortgage rates. In fact, long-term mortgage rates can and often do rise even while the Fed is cutting the short-term rate. Lawrence Yun, chief economist for the National Association of Realtors, or NAR, says long-term rates are determined by the global bond market and when investors believe there is an inflationary risk, they want an additional premium (in the term of higher rates) to account for that. When the Federal Reserve lowers short-term rates by loosening monetary policy, some global investors view it as a sign of more inflation in the future and therefore raise their rates.
"Consumers who are relying on what the Federal Reserve is doing will be surprised because mortgage rates at times may be doing exactly the opposite," says Yun.
In a recent Fed meeting, Chairman Ben Bernanke acknowledged that the spread between the Treasury rates and lending rates are widening. In many cases, the Fed's actions are offsetting the widening of the spreads, which are associated with signs of illiquidity, but it's been difficult for the Fed to do anything to lower long-term mortgage rates. Economic uncertainty has created volatility not just in the stock market but in the bond and mortgage market as well. In late February, long-term mortgage rates rose from 5.92 percent to 6.1 percent in just one week.