Rates Always Higher After the Last Fed Cut

Written by Posted On Thursday, 13 December 2007 16:00

The trick is guessing which cut will be "the last one"!

Bear with me here:

  • Four weeks ago Wall Street expected no rate cut.

  • Three weeks ago Wall Street thought maybe 1/4 point.

  • Two weeks ago Wall Street thought 1/2 point would be more likely.

After last Friday's Unemployment Numbers were released showing 94,000 more jobs created (higher than the anticipated number) and the unemployment rate remained steady at 4.7% all these "smart" economists are predicting (drum roll, please):

  • Maybe a rate cut but if there is one only a 1/4% drop. (do these experts actually get a paycheck for these predictions?)

This time they got lucky, or got it right, as the Fed in fact cut rates by a quarter point.

But why do rates go up after each rate cut?

You can look it up. Previous Fed cuts started a temporary euphoria in the stock and credit markets, but soon they sobered up and rates started going up again, erasing any gains they'd previously earned.

Mortgage rates are tied to their respective mortgage bond, which are traded throughout the day.

Mortgage bonds ANTICIPATE Fed moves ... they don't REACT to them.

If the mortgage markets (and other securities) figure the Fed is through with cutting rates that means the economy is most likely on the mend.

A healing economy drives up demand for products and services. A healing economy can stir up inflation.

Future rate moves now mean rate increases. And mortgage rates will hinge not on the likelihood of a Fed move but whether inflation is on the horizon.

If the Fed cuts rates by a quarter point then consumers get the wrong impression that their mortgage rate went down by 1/4%.

I will get calls from clients and the calls will go like this:

"Hey David, that's probably the last rate cut. I want to lock in now."

"Okay, but the rates are higher than they were before the cut," I say.

"Huh?"

Loyal readers of this column will know why rates went up and that's because bond traders figure the Fed has done enough (or too little, depending upon your perspective) and now the opposite is likely to occur and mortgage loan rates will back up to the mid to high six percent range.

(If you're counting, that's still pretty darned good)

If rates are always higher after the last Fed cut, how do you know when the last Fed cut will be?

You don't know. You have to guess, just like those economists who were all over the map predicting this last Fed cut.

But do you want to know a secret? The very best rates come just days before the last Fed cut. That's when you lock in. And how do you know when the last Fed cut is going to be?

You don't know. You have to guess.

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