The Federal Reserve doesn’t want to be blamed if Americans end up paying more for new mortgages in the coming weeks.
Interest rates normally rise when the Fed increases its main policy rate. Last week, just hours after the Fed raised its rate, big banks including JPMorgan Chase and Wells Fargo quickly announced they’d increase what’s known as the “prime rate,” a benchmark banks use to set interest rates on some business and personal loans.
But the Fed doesn’t want interest rates to significantly rise — and doesn’t think they will, according to researchers at the Federal Reserve Bank of New York.
That’s the message from a Monday blog post in which New York Fed researchers argued that rates on standard 30-year mortgages shouldn’t increase considerably as a result of the Fed’s decision last week to raise interest rates.
Their argument, in short: The public needn’t worry about the possibility of quickly rising interest rates on home mortgages so long as financial markets don’t misunderstand the Fed. Instead, households should look to the rate of interest demanded by traders to own long-term Treasury bonds — and not blame the Fed.
Last Wednesday, the Fed increased its main interest rate by about 0.25 percent after concluding that the U.S. economy had improved to the point that it no longer needed so much help from the central bank.
But the Fed is worried that the specter of higher rates could chill home buying and other big-ticket purchases in which the cost of financing influences buyers’ behavior. Fewer home purchases could lead to reduced prices, hurting an economy that depends on consumer spending and households’ perception of their own wealth.
New York Fed researchers reckon that past Fed decisions to increase rates mostly affected short-term loans and securities, such as adjustable-rate mortgages where the interest rate is fixed for the first year. Loans of longer duration, such as 30-year home loans, were less affected.
Instead, New York Fed researchers argued, rates on long-term consumer loans generally increase when financial markets anticipate rising rates on long-term Treasury bonds, an occurrence that heavily depends on how the Fed communicates future rate hikes.
For example, in 2013, when markets thought the Fed would reduce its support for the economy, the average interest rate on a new 30-year mortgage jumped more than 1 percentage point to about 4.5 percent between May and June of that year.
Interest rates on new home loans have since dropped to near-record lows. The average new fixed-rate 30-year mortgage carries a 3.97 percent interest rate, according to the most recent survey by Freddie Mac, the government-backed home loan giant.
In a sign of how low interest rates have fallen, the average rate on new 30-year mortgages was twice as high 15 years ago, in September 2000, according to an online database maintained by the Federal Reserve Bank of St. Louis.
Rates should stay low, Yellen said last week. Interest rates on longer loans “are unlikely to move … very much,” she said.
If mortgage rates jump as a result of the Fed’s move, Fed critics could seize the opportunity to argue that the Fed is mismanaging its primary responsibility. The Fed already is facing criticism from politicians and groups on both ends of the U.S. political spectrum. The Republican-led Congress is trying to reduce the Fed’s authority.
Some prominent economists, such as Larry Summers, formerly Obama’s top economic adviser, have warned that the Fed prematurely raised rates in part because it’s not clear that the U.S. economy is strong enough to withstand slightly higher borrowing costs.
Some Wall Street experts are trusting the Fed to not confuse traders.
“We take the Fed at its word that monetary tightening in 2016 will be gradual, and we expect only a modest increase in longer-term rates. Mortgage rates will tick higher but remain at historically low levels in 2016,” Sean Becketti, chief economist at Freddie Mac, said in a statement last week.
Unless Wall Street misunderstands the Fed’s intentions and sends rates on 30-year Treasury bonds soaring. If that happens, the Fed doesn’t want the blame.