Mortgage rates are directly affected by U.S. monetary policy is a variety of ways. Mortgage loans are typically insured through a government sponsored enterprise (GSE), which includes agencies like Freddie Mac and Fannie Mae. The loans are then packaged into mortgage-backed securities (MBS) and sold to investors in the bond market. Since bond prices and interest rate yields have an inverse relationship, the interaction of the markets and government monetary policy influence the fluctuation in rates.
Mortgage Rates and the Federal Reserve
While the Federal Reserve does not set private lender interest rates, it indirectly affects a variety of economic variables through its control over the federal funds rate. In essence, all credit unions, banks and other depository institutions must maintain minimum reserve balances in accounts held at Federal Reserve Banks. The Fed influences rates by adjusting the money supply to meet specific policy goals. When the money supply is increased, interest rates decline. Conversely, when the money supply decreases, interest rates rise. Either of these policy decisions by the Federal Reserve directly impacts mortgage rates.
The Importance of the 10-year Treasury
Mortgage rates are inexorably tied to the 10-year Treasury yield so mortgage lenders can reduce the effect of fluctuating economic cycles and drastic changes in interest rates. While the price and yield for Treasury bonds are set at auction, the Federal Reserve has a substantial influence on interest rates since it buys and sells Treasuries based on the direction it wants the market to move. The 10-year Treasury bond is used as a long-term interest rate benchmark by financial institutions and lenders. If you are looking to buy a new home and need a mortgage, it is important to evaluate the prevailing trend in 10-year Treasury yields.
