When people learn that I have spent many years writing about the Federal Reserve, there is almost always one question I get: Are mortgage rates going up or down?
It’s understandable why a person might think that the way to understand where mortgage rates are going — and thus whether to lock in a home loan now, or refinance, or whatever major borrowing decision he or she is facing — is to know what is going on inside the brain of Janet Yellen, the Fed chairwoman, and her colleagues. It’s also … wrong.
For most people, trying to parse the intentions of the Fed should play nearly no role in a decision of when to take out a mortgage or other loan. You should make your borrowing decisions based on current market rates and whether they make a given home purchase or refinancing decision affordable or not. Assume that neither you, nor your mortgage broker, nor your Uncle Ned, who watches a lot of Wall Street sharpies on CNBC, has any predictive capacity to know whether rates will be higher or lower a month from now.
Why would this be? Doesn’t the Fed set interest rates? Well, yes. But there are a lot of complexities that stand between that basic fact and the reality of what it will cost you to take out a home loan.
The Fed indeed sets a target for overnight bank lending rates, and buys and sells securities in order to keep market rates at that level. It has kept that rate near zero since the end of 2008, and is now making noises about raising it later this year, perhaps as soon as September.
That’s all well and good, but there are two things to remember. 1) Mortgages are usually based on long-term interest rates, not short-term interest rates, and 2) The Fed is not on some preordained path; rather, its policy will adjust depending on how the economy evolves.
The first point is crucial. When lenders make you a 30-year fixed-rate mortgage, they are essentially making a bet on the value of money for quite a long time. And in practice, that rate is set not by the whims of the banker at your local strip mall, but by the $21 trillion global bond market.
No matter whom you deal with for the mechanics of your mortgage, in other words, the rate you pay is ultimately set by asset managers, hedge funds, pension funds, sovereign wealth funds and countless other players who are buying and selling securities in hopes of getting the best deal. In effect, if you try to time your mortgage decision based on a hunch about the future direction of rates, you are betting that you have outsmarted the entire global bond market!
There’s no doubt that the Fed’s immediate plans factor into bond prices and hence the interest rate you pay for your mortgage. But it is a safe bet that people at BlackRock and Pimco and the Investment Corporation of Dubai, with hundreds of billions of dollars on the line, have spent a lot more time and brainpower thinking about what the Fed is going to do than you can possibly hope to.
By the time you see people on cable television or in the newspapers debating when the Fed is going to raise rates, it is a safe bet that those probabilities are already priced into the market.
That’s not to say markets are already priced exactly right. If they were, we wouldn’t see the kinds of swings in bond markets we have this year. It’s just that consistently predicting in what direction they are wrong is extraordinarily difficult, so much so that the people who pull it off become billionaires.
In short, I have met many elite fixed-income managers. If you think you have outsmarted them, you are probably wrong.
But it’s not just that in trying to outsmart the bond market you are betting against the most sophisticated investors on the planet. It’s also that many, many factors go into setting longer-term bond prices — and hence mortgage rates — beyond the outlook for Fed policy in the near future.
Among those factors, in no particular order: inflationary pressures now and in the future; long-term deficits (and hence debt issuance) by the United States government; future bond issuance by other governments and companies with excellent credit; long-term demand for safe assets; long-term economic growth in the United States and abroad; how the American government reforms (or doesn’t reform) the government-sponsored mortgage firms Fannie Mae and Freddie Mac; and, whew, the evolving role of the dollar as global reserve currency.
Those are all things that the Fed has little or no control over, and they all are as important, and arguably more important, to any forecast of what mortgage rates should be as when the Fed does its first rate increases.
Because there is so much uncertainty over all of those factors, Fed insiders don’t even agree on what their short-term interest rate should be at the end of next year. Their predictions range from under half a percent to about 3 percent, a range that implies significantly different expectations for American and global growth and inflation trends. Fed officials themselves have no idea how quickly they will raise rates. It’s a fool’s errand to think that you do.
So how should people make the decision on whether to take out or refinance a mortgage, if not by parsing Ms. Yellen’s speeches? By taking a deep breath, and running the calculations to decide whether they are better off taking action at current prices or not.
That doesn’t mean you’ll necessarily get it right. But sometimes even the most knowledgeable people about Fed policy get it wrong. I know of a guy whose insights into the Fed are better than almost anybody else’s. He refinanced his mortgage on a house in Washington in 2011, getting a 30-year fixed-rate mortgage at 4.25 percent.
He should have waited a year. By late 2012, average rates were almost a full percentage point lower. But by then Ben Bernanke was stuck with his higher mortgage rate, and, presumably, a bit of regret.