The Federal Reserve

TYears ago, most homeowners believed the Federal Reserve set mortgage interest rates. Since the dawn of the information age consisting of 24 hour cable news channels and the internet, most homeowners have become more savvy and now understand that the Federal Reserve does not control mortgage interest rates (see 10 Year Bond for more info on this). So, what is the role of the Federal Reserve as it relates to mortgages and what do they do?

The Federal Reserve plays a large role in inflation expectations. This is because the bond market's perception of how well the Federal Reserve is controlling inflation through the administration of short-term interest rates determines longer term interest rates, such as the yield of the U.S. Treasury 10 year bond.

In other words, the Federal Reserve sets current short-term interest rates, which the market interprets to determine long-term interest rates such as the yield on the U.S. Treasury 10-year bond. Remember, the interest rates on mortgages are highly correlated with the yield of the U.S. Treasury 10 year bond. If you're trying to forecast what fixed rate mortgage interest rates will do in the future, watch and understand the yield on the U.S. Treasury 10 year bond and follow what the market is saying about Federal Reserve monetary policy.

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