Knowing Better

Interest rates represent the cost of money.  When one borrows from a financial institution, they are charged for the pleasure of doing business with the firm.  This incentivizes banks and other lending companies to take the risk associated with lending money: borrowers defaulting.  Rates are determined by a variety of variables which can be summed up as “market conditions.” 

One special market condition is the Federal Reserve.  America’s central bankers get together every six weeks to discuss the size and rate of growth of the nation’s money supply, aka monetary policy.  More specifically, this culminates in the setting of a target rate that large commercial banks charge each other for overnight borrowing.  This Fed Funds Rate is relevant to only those banks overseen by the Federal Reserve.  In other words, it does not directly impact the rates you or other consumers are charged for your borrowing needs (e.g., mortgage interest).  Yes, there is some correlation but not a direct link.  Instead, many other market forces influence how expensive borrowing becomes for a typical American.

We can demonstrate the Fed Funds Rate’s limited impact by comparing the rate of change for mortgage rates since the central bank embarked on its interest rate hikes which began nearly three years ago.  If the central bank were able to have more influence via the Fed Funds Rate, we would be able to see long-term rates rise with similar velocity to the overnight rate which has risen from virtually zero to roughly 2.25.  Instead, 30-year, conventional, fixed-rate mortgage rate increases have been relatively tame.  Rising from an average of 4.05 percent in July 2015 (before the Fed started raising rates) to an average of 4.83 percent last month according to Freddie Mac data contained in the existing home sale report from the National Association of Realtors. 

Economists should understand that the Federal Reserve is not the only power causing interest rates to rise and fall.  However, the National Association of Realtor’s economist, Lawrence Yun, decided to call out the central bank in their latest release for existing home sales.  He writes, “rising interest rates and increasing home prices continue to suppress the rate of first-time homebuyers. Home sales could further decline before stabilizing. The Federal Reserve should, therefore, re-evaluate its monetary policy of tightening credit, especially in light of softening inflationary pressures, to help ease the financial burden on potential first-time buyers and assure a slump in the market causes no lasting damage to the economy.”  Rates have been improving for short-term deposit vehicles (assisting savers) and have only climbed marginally in the past three years for long-term lending (hurting borrowers).  Attempting to repeal the business cycle via monetary policy doesn’t seem like a good idea to Atlas when the actions of the past three years haven’t had more than a nominal effect on borrowing costs.

Here's the point of all of this.  Mr. Yun, like others, has an ax to grind.  He is seeing his segment of the economy (existing home sales) slow and wants something to stimulate it again.  However, a business cycle cannot ebb and flow if it is constantly goosed.  Many readers will remember mortgage rates rising above double digits, but the economy chugged ahead, albeit slow at times.  Interest rates will fluctuate, stock prices will fluctuate, home values will rise and fall, but America’s economy will continue moving forward.  It is not central bank actions that make this nation great; numerous variables create our dynamism.  Atlas is prepared to embrace the business cycle even if decelerations are ahead.  We will continue monitoring market indicators, adjusting our managed portfolios based on their conditions.