The widely held belief that a reduction in Federal Reserve interest rates will lead to a decrease in mortgage rates, thus boosting new home sales, is actually incorrect. Mortgages are long-term commitments, so a drop in short-term rates does not necessarily result in a corresponding drop in long-term rates. Additionally, if the lower short-term rate is not market-based but is caused by the Fed, its longevity is uncertain. Looking back at the past 37 years, there is evidence that this link between short-term and long-term rates is missing.
Alan Greenspan’s experiment with near-zero real interest rates in the late 1980s did not lead to a decrease in mortgage rates. Similarly, Ben Bernanke’s near-zero nominal rates did not significantly impact mortgage rates either. Even under the leadership of Jerome Powell, heavy buying of mortgage securities by the Fed and regional banks did not prevent mortgage rates from rising when inflation spiked and short-term interest rates were raised. Currently, mortgage rates are at reasonable, market-based levels, so a reduction in short-term rates by the Fed may not have much effect on long-term mortgage rates.
Therefore, it may be wise to disregard the simplistic idea that the Fed has the power to boost new home sales by lowering short-term rates. Much of the commentary surrounding this topic is oversimplified and lacks support in reality. It is important to consider alternative strategies based on a more nuanced understanding of the market. For instance, if home builder stocks are rising due to comments made by Powell, it may not be a valid reason to expect an increase in new home sales, and it might be best to avoid potential losses by refraining from buying or holding onto these stocks.
In conclusion, the correlation between short-term interest rates set by the Fed and long-term mortgage rates is not as straightforward as commonly believed. Historical data shows that even drastic measures taken by previous Fed chairs have not consistently led to changes in mortgage rates. In the current market environment, where mortgage rates are already at reasonable levels, a slight decrease in short-term rates may not have a significant impact. It is essential to approach investment decisions with a critical eye and not solely rely on popular yet simplistic notions about market dynamics.
