I think that current homeowners will be asking themselves this question a lot in the coming days, especially for those that didn't take my advice in my last newsletter to stop being picky and refinance.  But I thought I'd offer a layman's explanation here, as I suspect a number of the business articles will be written for CFO types.



Let's start with some myth clarifying.


Myths about Interest Rates


  1. The Fed controls interest rates:  This is TOTALLY FALSE.  And if you learn anything from this post, you should learn that.  We all know that the Fed, or more accurately the Governors of Federal Reserve, has an impact or rates.  But it's INDIRECT.  Simplistically, they set rates of lending for financial institutions. And financial institutions set their rates based on those rates. But the market, which includes large banks, large companies, municipalities and other countries, makes bets on the direction of rates. For the purposes of this post, we'll call these guys "Treasury Traders".  If the Treasury Traders think rates are headed up, they sell treasuries (Treasuries are US Govt Bonds) and other long term securities, If the Treasury Traders think rates are headed down, they buy them.  I won't get into why they do this, other than to say if they guess right they make money.  The important thing here is that when Treasury Traders sell treasuries, the rate goes up.
  2. The Fed wants rates at 3.5%.  This is probably false too.  We don't actually know WHAT interest rate the fed would like to see for home purchases and refis.  They aren't likely to tell us.  We do know that they want rates low.  But what is low?  I would argue that low is anything under 6%.  And anything under 5% is SUPER low.  And we have been spoiled lately, as we hardly remember the days of 7% rates, let alone 10%.  My opinions aside, the only definition of low that matters is the Feds.  And we don't know what that is.



How Interest Rates May Change going into 2011


OK.  So much for the myths.  So what's going on?  Well, basically, what was happening was the FED was buying Treasuries (in addition to setting low rates), AND the economic news was lukewarm at best.  The economic outlook encouraged the Treasury Traders to buy bonds, and the combination of those two actions produced the SUPER LOW rates of the last couple of months.  But what happened is the economic news got better, at least as far as the "Treasury Traders" were concerned, so they SOLD treasuries, and that has boosted rates.  The Fed's not doing anything different, but the Fed can't control the actions of the Treasury Traders, and there are too many of them for the Fed to stop them once they start doing something.  


So what will happen in the future?  Well, it's not clear.  If the economic news gets SO GOOD, that jobs and hiring picks up, well, the Fed may stop purchases and let the economy take over.  That means rates will continue to go up. If the economic news gets bad (especially global news), the Treasury Traders may rush back to treasuries, and rates will fall.  Most likely is that we'll get a lot of mixed messages about the economy, and rates will go up, and then go down, but I don't think they'll return to the lows they were at.  If I knew though, I wouldn't have to sell real estate......


Hope you enjoyed the post.


Other Posts in my thread:  Housing and Economics:  Understanding the Beast that is Your Largest Investment: