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Mortgage rates seen holding steady
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The Federal Reserve's decision last week not to change a key short-term lending rate reinforces the likelihood that interest rates on long-term loans such as mortgages will remain near their current levels for the next few months, experts say.
Fed policymakers cited a relative lack of inflation and slow job growth as reasons for keeping the federal funds rate -- the rate that banks charge each other for short-term loans -- untouched at 1 percent, a 45-year low. They said the low rates, combined with increased worker productivity, are boosting the economy.
For the past six months, the group -- which sets the nation's monetary policy -- has said it would leave rates alone for a "considerable period." Wednesday, it said it "can be patient in removing" the low rates.
"The typical overreaction to subtle wording changes was what unfolded (Wednesday)," said Greg McBride, senior financial analyst at Bankrate.com. "The initial shock will wear off quickly if the job picture continues to be unfavorable."
There is no direct relationship between the Fed's decision and mortgage rates. But those rates move in reaction to the same economic forces that the Fed studies, so Wednesday's decision simply underlined what the mortgage markets already have factored in: that the threat of inflation is low, and that job creation is still wanting.
In general, the lack of inflationary pressure is the main reason mortgage rates are low, both for home buyers and those in the market to refinance, experts say. Last week mortgage financing company Freddie Mac reported a national average rate for 30-year fixed mortgages of 5.64 percent. The record low of 5.21 percent was set in June.
When inflation is low and expected to stay that way, investors in capital markets -- the source of most of the money loaned in the form of mortgages -- can invest in loans with low interest rates and still make a profit.
If inflation begins to rise -- say, because of wage increases -- investors will seek higher interest rates to maintain their profit margin, said Frank Nothaft, chief economist at Freddie Mac.
(Fannie Mae and Freddie Mac are the government-sponsored entities that bundle large numbers of mortgages and sell them to investors as "mortgage-backed securities.")
It's a simplified example, but if someone has loaned money at 5 percent while inflation is only 1 percent, and then inflation climbs to 2 percent, the value of the lender's investment has been eroded by inflation. The money the borrower is paying him now buys him less, so he will look for an investment that pays a higher interest rate.
Nothaft said he expects "very little pressure to push up inflation" in 2004. He forecasts that rates for 30-year loans will end the year at about 6 percent.
Interest rates for 30-year mortgages tend to follow the yield on the 10-year Treasury bond, one of the safest bond investments because the U.S. government guarantees their repayment.
Without better news on the job front, economists say, inflation is likely to stay at bay and loan rates to remain relatively low.
"The job picture here is going to recover more slowly than the nation," said Kris Mitchener, assistant professor of economics at the Leavey School of Business at Santa Clara University. "There's no pressure yet for wage inflation. The good, strong productivity numbers we've been seeing allow firms to sell their goods and not raise prices."
The last few national reports on jobs have been disappointing, said Keith Gumbinger, vice president of HSH Associates, a publisher of information on mortgages and consumer loans. The disappointing news has pushed down bond yields, and therefore mortgage rates.
"If we finally hit one that's actually considerably stronger than expected, I think the market would stand up and take notice," meaning rates would rise to slightly more than 6 percent, Gumbinger said.
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