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Writer's pictureJesus Espina-Velosa

Decoding the Fed: How Politics and Policies Impact your Interest Rate

How does inflation impact mortgage rates? Why is there so much focus on the Federal Reserve and what on earth do they really do? Why is there so much news coverage about the unemployment numbers and the health of the US economy? Do I need to be an expert on what the 10-Year Treasury is and what inverted yield curves are to understand what’s going on with interest rates?


These are all questions you’ve probably asked yourself over the course of the last several years (or maybe not), especially if you’ve been shopping for a house or a car, or you’ve seen the rates on your credit cards skyrocket.


The good news is that you don’t need a PhD in Economics to keep up with what’s going on with interest rates. There are a few simple factors that we will go over today and give you some key insights.


Domestic Economic Indicators


The heartbeat of mortgage interest rates pulses to the rhythm of economic indicators. Inflation rates, employment data, and overall economic health are instrumental in shaping the lending landscape. Inflation and Unemployment targets set by the Federal Reserve act as bell weathers for the health of the economy.


Inflation is a general increase in prices and fall in the purchasing value of money. Inflation is why bacon is $9 at the store. A little bit of inflation is actually a good thing because it encourages spending and spending means growth. This is why you’ll often hear of the 2% inflation target the Federal Reserve is working to maintain.


Unemployment numbers indicate the health of the labor market. Every election season you will hear politicians talk about adding jobs. Adding more jobs will theoretically lower the unemployment rate. A healthy economy will consistently add jobs and lower unemployment.


The Federal Reserve looks at these two indicators to inform their policies and ultimately impact your Interest Rate.


Political Stability and Global Economic Trends


Beyond economic factors, the stability of a nation's political environment and policy decisions also contribute to Mortgage Interest Rates. Political uncertainty or drastic policy changes can introduce volatility in financial markets. Uncertainty is bad in the economic world. The spookier investors get, the less capital is available to help individuals and small businesses. When there are less lenders willing to provide capital, everybody loses because those that do lend can charge a premium for taking on more risk.


Military conflict is also a factor. Take the War in Ukraine. The immediate impact was an increase in oil and grain prices. Oil and grain traders recognized the cost to get those goods were going to get more expensive due to economic sanctions on Russian oil as well as poor projections for Ukrainian grain.


These higher prices translate to higher inflation because gas, food and housing prices have the biggest impact on inflation.


Higher inflation means that the Federal Reserve must aggressively raise rates to curb inflation (more on that later).


Higher rates and scared investors mean there is less access to capital for individuals and businesses.


Political policy decisions are harder to quantify and can often take longer to materialize in the economic world. Changes in the political landscape impact how Central Banks, like the Federal Reserve, exercise their financial levers to control economic activity, through the way of the Federal Funds Rate


The Fed and their Levers


In the United States of America, the Federal Reserve wields considerable influence by implementing policies that impact Interest Rates and the economy as a whole. One of the main levers is the Federal Fund Rate, which is simply the interest rate they charge Banks and Lenders for capital (i.e. money). These Banks and Lenders, in turn, charge you Interest to borrow money for your home, car, credit cards, small business loans, etc. If the Federal Fund Rate goes up, so does your Interest Rates.


The Fed leverages the Federal Funds Rate in one of two ways:

  • By lowering the rate to grow economic activity. Making it cheaper for banks to lend and for consumers and businesses to borrow money when times are tough. Much like what we experienced during COVID.

  • By raising the rate to make it more expensive to borrow money to fight inflation. Like we have seen post-COVID with the increase to interest rates.

In 2020 and 2021, during COVID, the Federal Funds Rate was near zero which in turn gave us the best Mortgage Rates in our history (raise your hand if you have a rate below 3%). Conversely, in the early 1980’s, the Federal Funds Rate was near 20% and we saw Mortgage Interest Rates in the same 20% range.


This is greatly simplifying how money is borrowed in our economy and there are numerous types of short-term interest rates that all play a part. However, to understand Mortgage Interest Rates we are going to focus on the 10-year Treasury Bond, also known as the 10-year T Note. Think of the 10-year T Note as having more stability than the short-term rates which are more volatile. When you get a mortgage, your term is typically between 10 and 30 years, with a 30 year term being the most common. The longer term rates of a mortgage rely on the stability of the 10-Year Treasury Bond.


It can be easy to get lost in the day to day of economic activity and reports, which is why just keeping an eye on the 10-year Treasury can help you be in tune with where mortgage rates are. This graph below shows how the Mortgage Rate and the 10-Year Treasury are in lock-step.


Mortgage Rate and the 10-Yr Treasury
Mortgage Rate and the 10-Yr Treasury

Outro


As we can see, domestic factors like Inflation and Unemployment, as well as Global Political trends have an impact on how the Federal Reserve sets the policies on borrowing money.


While its good to be informed about these factors, remember you do have some control over your own interest rate based on your individual profile. We discussed these factors in a prior article:

  • Your Credit Score (FICO)

  • Loan to Value ratio (LTV)

  • Property Type you are acquiring (Single Family, Multi-Family, Condo, MFH)

  • Whether you are paying discount points (cost) to acquire a lower rate and have a lower monthly payment, but have higher closing costs.

  • Whether you are getting lender credits (rebate) to acquire a higher rate and have a higher monthly payment, but pay lower closing costs.

  • How to best use the Par rate to get an apples-to-apples comparison from lender to lender

If you are interested in learning more and keeping up with changing trends we urge you to follow @federalreserve and @stlouisfed on Twitter (X?). Also, follow Leadership Mortgage on our socials to get the inside scoop on the Mortgage industry.



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