How Do Treasury Bonds Relate to Interest Rates?
After interest rates have risen over the past few years, the Federal Reserve cut the federal funds rate last week for the first time since 2008. The move is annoying financial analysts, but what does it mean for you?
You are certainly not the only one who is interested in this. The Federal Open Market Committee (FOMC), which sets monetary policy for the Federal Reserve, meets eight times a year to review and set the federal funds rate, so it seems like every time you turn around, the Fed is talking about interest rates. rates.
The federal funds rate helps determine Libor, the rate that banks charge each other for short-term loans to ensure they have enough cash to process our day-to-day transactions and loan requests. If banks want to borrow from the Federal Reserve, they pay a so-called discount rate, which is fixed and always slightly higher than the federal funds rate, to encourage banks to borrow from each other rather than go to the Federal Reserve.
How the federal funds rate affects short-term interest rates
The federal funds rate is not a requirement for banks, although Investopedia notes that the Federal Reserve may adjust the money supply to bring interest rates closer to the target set by the federal funds rate.
The federal funds rate affects us because it affects the base rate, which is the rate of interest that lenders charge their major clients. The base rate is usually higher than the federal funds rate. When the FOMC adjusts the federal funds rate, it affects short-term variable interest rates, but you don’t see your own variable interest rates on loans or credit cards going up or down immediately. As noted by The Balance, it may take a year and a half before the shift in federal funds rates begins across the economy.
After all, you, as the average consumer, may be thinking about how the federal funds rate will change with the opposite effect. If the rate goes down, it stimulates the economy by encouraging lending. This is why you often see the stock market have a good day right after a rate cut. When the rate rises, banks often tighten their lending requirements. This does not mean that you will not be able to get a car loan or apply for a new credit card, but you will probably pay a slightly higher interest rate even if you have good credit.
Federal funds rate and Treasury bonds affect mortgage rates
If the federal funds rate affects short-term interest rates, what about long-term interest, like what you pay on a fixed rate mortgage? Aspiring homeowners often keep an eye on the federal funds rate because it can affect fixed mortgage rates. But this is not a guarantee that they will be directly linked if rates change.
Mortgage rates are based on the bond market, in particular the mortgage bond market. Just like you can have your own investment portfolio, the Federal Reserve has its own. It is comprised of about 60% of US Treasury securities and about 40% of mortgage-backed securities, LendingTree said . This is why so many people believe that the yield on 10-year Treasuries is the only thing that influences mortgage rates, but it is just a fraction of the Fed’s portfolio. If the prices of mortgage-backed securities rise, mortgage rates are likely to fall; if prices fall, mortgage rates will rise.
“In practice, bad economic news leads to lower mortgage rates, and good economic news leads to higher rates,” writes Colin Robertson of The Truth About Mortgage . You are more likely to see a very small shift in rates, rather than the large recessionary swings that you may fear. But a small increase or decrease in your interest rate can affect your long-term spending on the value of your home.
This is why people think about mortgage rates when the Federal Reserve changes the federal funds rate. But these rate swings represent a complex trickle down effect, not the Fed doing the paperwork for mortgage lenders with red feathers.