Floor vs Ceiling: Weekly Wire with Drew

Floor vs Ceiling

In terms of Yields we often discuss the floor vs the ceiling in relation to Mortgage Rates.  This is a result of the FOMC (Federal Open Market Committee) targeting the Federal Funds Rate as a primary tool to conduct monetary policy.  Fed Funds rate is a rate with a very short maturity and movements in this rate (which is an overnight interest rate) often influence longer-term rates.  Many of us heard during Covid that the Fed Funds rate was at 0, but this didn’t bring mortgage rates to 0%.  We saw lows in the upper 2’s and low 3’s.  Mortgage Rates often fluctuate to a degree several percentage points above the Fed Funds Rate. The degree of difference can often vary, a general rule of thumb is that the lower the Fed Funds Rate the larger the degree of separation, and the opposite for higher Fed Funds Rate, a lower degree of separation.

The current Fed Funds Rate is set to be between 5% and 5.25%, this is after a year straight of interest rate hikes (except for the most recent meeting where they did not increase). With the current rate set, Mortgage rates have generally ranged from 1% to 1.5% over that Fund Rate, but due to volatility in the market the rate has fluctuated.  We can assume the floor to be about 1% over the Fund rate (during low volatility) and the ceiling to be about 2% over (during high volatility).  This is why we have experienced fluctuations from a 6.25% to 7.25%.

The trend over the last 2 weeks has been odd as we have seen decreased volatility and strong economic data indicating that inflation is coming down, yet yields have tried to hold closer to the ceiling with rates still fluctuating in the 6.626-6.875% range.  Bonds, in a sense, have been biding their time looking for more meaningful data and indicators before they react with movement closer to the floor. It is as if the Bond Market is waiting for bigger news on inflation and the economy. This is mainly due to the fact that our economy has remained extremely resilient, despite the rampant inflation, thus making many very skeptical of future timelines.  I tend to rely on the data more than skepticism or opinion. Data shows us that inflation is come down from 11.5% last year to a current 4%.  In the last month it dropped from 4.9% to 4%.  JOLT reports show constriction in the work force with fewer jobs becoming available, and unemployment has increased. This combined with multiple other data reports show that the combination of many factors is having the desired effect on the economy and is pulling us through which is the main goal of the FED.

Remember that though the FOMC sets the FED Funds Rate, traders and market volatility determine the prices/yields of bonds which, in turn, determine the day-to-day changes in mortgage rates.

Drew Waack | Mortgage Advisor

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