What Could The Fed Do?

by Tyler Osby on June 25, 2008


Fed Day



It’s official, it’s Fed Day. Today (Wednesday, June 25th), the Fed will be making their statement this afternoon at 2:00ET. It’s a big deal for the mortgage market, but not for the reasons you might think it matters.

What Does The Fed Funds Rate Effect?

  • Credit Card Rates
  • Auto Loans (in some instances)
  • Home Equity Lines of Credit (or HELOCs)
  • Other revolving accounts that are tied to the FFR with a margin.
  • Inflation (It’s a long story).

What Does the Fed Funds Rate NOT Effect

  • Mortgage Rates
  • Many other things that I don’t particularly pay close attention to. Honesty is the best policy.
So, Why Does The News Matter Then?
Simply put, inflation. Inflation is the name of the game today. IF the Fed makes money cheap (via the FFR), consumer spending goes up and then inflation follows. IF the Fed hikes interest rates, they’re making an effort at making money slightly more expensive to slow the spending and then inflation reverses.
You spend more money when money’s cheaper to borrow right?… So does the rest of our country.

What Could The Fed Do?
Really there are three different ‘moves’ the fed could take. Not only is the ‘move’ important today, but the markets will pay extremely close attention to the language in the statement. If inflation is a worry (which it is), it’s important to know how the Fed is going to react to it. That’s what we’ll hopefully hear about this afternoon.
Okay, here are the three options:
  1. The fed could leave the fed funds rate unchanged.
    If this happens, traders may fear that inflation is going to get (slightly) out of control and they will probably sell mortgage backed securities (what mortgage rates ARE based on). Depending on how much they sell, rates will get worse.
  2. The fed could hike up the fed funds rate.
    If this happens, traders will feel like the fed is committed to keeping inflation from killing us under control. Traders would definitely put more money in mortgage backed securities and rates would improve. Improve significantly.
  3. The fed could cut the fed funds rate again.
    Pigs could fly out of my… but it doesn’t mean it should happen. If the Fed decided to cut (again), we’d have some traders moving out of mortgage backed securities fearing inflation will kill the value of the bond and putting all of their money in stocks. This would be great for stocks and horrible… yes HORRIBLE for mortgage rates.
    I really don’t seeing the fed taking this measure. I think they’ve stimulated the economy enough.
What Will Happen?
Anyone can speculate, but I get paid to have an opinion. So here we go, I think the Fed will leave the FFR unchanged. Rates might increase slightly this afternoon, but I think the bond market has already somewhat cooked this move in to their position.
Truth is, traders are extremely emotional anymore – so we could see a big swing today. If that happens, we’ll just have to give the market a couple of days to work it self out.

The Kicker
Okay, here’s the kicker. This Friday (June 27th), the PCE report comes out. The PCE report is the Fed’s favorite way to measure inflation. Currently, the PCE is 2.1% (the fed’s target range is between 1 and 2%). So, we’re slightly higher than the fed would like to see. Getting back on subject – the news on Friday will really help the markets determine how they feel about the Fed’s move today (Wednesday, June 25th). Everyone has 20/20 hindsight.

In Closing
With seven consecutive fed cuts, I’m sure we’ll see them at least leave the Fed Funds Rate unchanged. If you didn’t know (and I’m not sure why you would unless you’re a dork like me), when the Fed takes action (such as cutting interest rates) it takes roughly six months to see the effects of that move. Based on that little nugget of knowledge, we’re finally seeing the results of the Fed’s initial rate cuts. It’s obvious that if they’re worried about inflation, they need to start hiking. It’s just a matter of time.

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