Kevin writes: Why are interest rates on mortgages going down when the Fed rates are going up?
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Welcome back to real investing. I’m Tim Herriage. Thank you for spending your time with me again today. Today, Kevin writes, why are interest rates on mortgages going down when the fed rates are going up? <laugh> it’s a great question, Kevin. So if you look at mortgages, right, and I think I’ve talked about this a couple times before, much of it’s driven off of long term interest rates, right? So, uh, the mortgage is 15, 20, 30 years. Um, the federal funds rate is a short term borrowing rate, right? And much of the 10 year treasury and the 30 year fixed rate mortgage bonds has to do with long-term rates. And, and so right now, what you’re seeing in the economy is everyone believes, feels or thinks that rates will be relatively high relative to the preceding 24 months, not relative to history over the next six to 12 months.
People also think that rates will be lower 12 to 24 months from now, because if the entire narrative is the fed has to slow down inflation, the way you slow down inflation is to reduce demand, not reduce supply, right? The two pillars, well, the way you, the way the federal reserve can reduce demand is make it harder to buy houses, make it harder to finance corporate debt, make it harder to borrow on a credit card, right? These are all things that reduce demand. Well, it’s known as demand destruction. What all the people that are a lot smarter than me are now afraid of or worried about is will it create a recession? And if it creates a recession, what is the federal reserve? Do they lower rates? So right now what you’re experiencing is in June, there was a lot of panic and rates went up too fast.
I still believe June 23rd was kind of the peak of the 30 year mortgage for this year and next year and the year after now, who knows after that. Um, and if you kind of look on my social media, you’ll see a graph where there was a, uh, it had the federal funds rate on the bottom and then the, um, oh my gosh, 10 year treasury after it. And then it had the 30 year fixed rate above that. So when you look the tenure year treasury and the 30 year fix really move in concert with each other, but there was a kind of widened gap in between. It’s called a spread in between the 10 year treasury and the 30 year fixed in June. And that was just, bonds were really hard to sell in June on 30 year loans because the investors weren’t sure if it, it was gonna be an 8% interest rate or a 6% interest rate at the end of the year or a 5%.
So the spread gapped out, it got wide it’s come back in and now actually rates went up this week. And the reason is they went down a little more last week. And, um, now with another negative, um, inflation report, meaning it’s, it’s a negative report, meaning inflation went down, which is actually a positive for <laugh> the economy. Um, now there’s a consensus that maybe the fed won’t raise rates as high as fast, then there’s less concern about short term interest rates. Well then there’s less belief that we’ll get into a fast recession and the fed will have to lower rates. So now you start looking at long term rates and maybe they don’t go back down. So it’s a function of supply and demand, but it’s also a function of guesswork by the capital markets because they are loaning you money for 30 years and or 15 or 20 or whatever.
And so they’re trying to make sure that they don’t want to do a 2% loan when the going rate 10 years from now will be 20%. If that that’s not like a prediction or anything, it’s just an example. So that’s where it all comes from. It’s just the difference in the 10 year treasuries and the, uh, the kinda more two year death facilities and then the 30 year death facilities, but then also there’s buckets of each securitization that have to be full filled up. And if they’re not being filled up, you have to, you know, lower the price on ’em. So that’s the way it works. Hope that helps it’s it’s um, I’m still, I still learn these things all the time, but that’s the, everybody was really confused why the federal funds rate went up 75 basis points and mortgage rates dropped 75 basis points or 50 basis points.
And the reason was there, they had gapped out too much. And now the consensus is that they’ll be that the rate increases will end this year and we should see rate decreases next year. So I think we’re in a nice, healthy environment right now. I think it stays about where it is right now for the next, uh, in couple months. And then I, you know, I, I really think that the homeowner loans honestly good and healthy. If, if the federal funds rate stayed around 2%, which is the target inflation and homeowner rates stayed four and a half, 5%, that’d be great. And if the investor loans stayed five and a half, 6%, that’d be great too. So, uh, less is better, but we also create too much demand, which then gets us in the pickle we’re in right now. I hope that helps Kevin. Thanks for taking time. If you’re listening and you have questions hop over to, Ihavelunchmoney.com, submit your question and I will do my best to get to every question as time allows. Thank you for spending your time with me and I’ll see you tomorrow.
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