How Will the Fed Affect the Market ?

Markets are unsure of what the Federal Reserve will do at its October 2008 FOMC meeting

The Federal Open Market Committee adjourns from its scheduled 2-day meeting today at 2:15 P.M. ET and the markets are eagerly awaiting the central bank's press release.

In it, Fed Chairman Ben Bernanke is expected to address the U.S. economy, the future of credit, and the new Fed Funds Rate.

It's this last point to which mortgage rate shoppers should pay attention -- when the Fed Funds Rate falls, mortgage rates tend to rise.

The inverse relationship between mortgage rates and the Fed Funds Rate is based on the idea that cuts to the Fed Funds Rate are designed to add gas to U.S. economic engine.

In theory, over time, Fed Funds Rate cuts work to improve Corporate America's balance sheets, thereby rewarding shareholders. Therefore, when the Fed Funds Rate falls, or is expected to fall, investors often rush to buy stocks before their prices get bid up. Part of that process, of course, includes selling the "safe" parts of their portfolio which are usually loaded with mortgage-backed bonds.

If you were looking for a reason why mortgage rates tanked Tuesday while the Dow Jones added 11%, now you have it.

The Fed Funds Rate stands at 1.500% and markets are split about how far the FOMC will cut it this afternoon:

  • A "pause" is expected by 2 percent of traders
  • A 0.250% rate cut is expected by 5 percent of traders
  • A 0.500% rate cut is expected by 45 percent of traders
  • A 0.750% rate cut is expected by 40 percent of traders
  • A 1.000% rate cut is expected by 8 percent of traders

Without a consensus opinion among traders, no matter what the Fed does today, a lot of investors will be forced to rebalance their portfolios to account for their "bad bets". This will add to market volatility for sure.

Mortgage rates are calm this morning. The calm likely won't last. If you are floating your mortgage rate and want to avoid additional risk, consider locking your rate prior to the FOMC press release.

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