For the second time this month, the Federal Reserve has cut a key short-term interest rate, but the widely anticipated move was expected to have little immediate impact on mortgage rates.
In slashing its target for the federal funds overnight rate by 50 basis points, to 1 percent, the Federal Open Market Committee said a decline in consumer expenditures has "markedly" slowed economic activity.
Weaker prospects for economic growth, and declines in energy prices and other commodities, have the Fed expecting that inflation will moderate in coming quarters, providing leeway to cut short-term rates to near historic lows.
The Fed today also unanimously approved a 50-basis-point cut in the discount rate to 1.25 percent. The Fed also made emergency 50-basis-point cuts in the federal funds and discount rates on Oct. 8 (see story).
The federal funds rate — the rate banks charge each other for overnight loans — was gradually reduced to 1 percent after the dot-com stock market crash, where it stayed for much of 2003 and 2004. It has not been lower than 1 percent since 1958.
Cutting short-term interest rates is intended to stimulate borrowing. While some home equity loans are tied to the federal funds rate, most adjustable-rate mortgage loans are indexed to the London Interbank Offered Rate, or LIBOR.
LIBOR has remained elevated in recent weeks despite efforts by central banks around the world to make money more easily available, as banks remain reluctant to loan money to each other because of fears of insolvency (see story).
Fixed-rate mortgage rates are largely determined by the willingness of secondary market investors to purchase mortgage-backed securities. Long-term mortgage rates, which have historically tracked longer-term investments such as the 10-year Treasury, have not come down in concert with Treasuries because they are in less demand by investors.
Fannie Mae and Freddie Mac, which guarantee most of the mortgage-backed securities purchased on the secondary market, are also major investors in them. Both companies are facing higher borrowing costs.
Holdings of Fannie’s and Freddie’s debt and mortgage-backed securities by foreign central banks plummeted by $47 billion during the four weeks ending Oct. 22, to $923.4 billion, Bloomberg News reported.
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