Federal Reserve’s surprise 0.750% rate cut this morning 1/22/2008

By Todd Abelson NMLS #180858 on .


As promised, last week was heavy on data and on drama.  And mortgage rates continued their slide lower. 

This week, by contrast, is devoid of data and markets are already digesting the Federal Reserve’s surprise 0.750% rate cut this morning. 

Mortgage rates are falling in response, but not because of what the Fed did as much as what the Fed implied by doing it.

The Federal Reserve does not control mortgage rates, per se, but it does exert an influence.  This is because when the Federal Open Market Committee makes changes to the Fed Funds Rate, it is making a broader statement about the health of the economy.

This morning, and in advance of its 2-day meeting January 29-30, the Federal Reserve chopped the Fed Funds Rate by 75 basis points to 3.500%.  This signals to markets that the Federal Reserve is keen on engineering a soft landing for the economy.

Mortgage rates are falling for a different reason. 

The chart above is from last week and illustrates what traders thought the Fed would do to the Fed Funds Rate at its January meeting.

Note that over a two-month span, the market expectation changed.  The blue line (4.250%) represents the Fed Funds Rate prior to this morning.

Two months ago, markets overwhelmingly expected the FOMC to lower the Fed Funds Rate by 0.250% at its January get-together(as represented by the white line). 

As time passed, however, that expectation changed and mortgage rates changed, too.  This is not a correlated event, however.  Both the Fed Funds Rate and mortgage rates tend to fall during times of economic weakness.

On the right of the chart is last Friday.  At that time, market expectations for the January meeting were equally split between a 0.500% drop and a 0.750% drop (as represented by the orange and red lines, respectively).

The 0.500% drop signals weakness; the 0.750% signals dramatic weakness.

So, after the Federal Reserve’s surprise move this morning, it turns out that the Fed sees dramatic weakness.  Mortgage markets are reacting to this “news” and resetting their bets by buying more mortgage bonds.

This added demand is causing rates to fall, but not anywhere near the three-quarter percent levels by which the Fed cut the Fed Funds Rate. 

Mortgage rates are down slightly.

(Image courtesy: Federal Reserve Bank of Cleveland)

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