FED Rate Cuts: How Low Can They Go? part II

After yesterday’s emergency .75% rate cut by the Federal Open Market Committee (FOMC), I have received numerous calls and questions as to how low will the FED go and how low will Fixed Rates go? If you read my previous post on the FED Rate Cuts, you know that the two rates don’t always move in the same direction, in fact they more often than not, move in opposite directions.

The FED has tried to be as transparent as possible, especially under the leadership of Ben Bernanke. The goal of transparency is to limit “surprises” in what the FED does and says. In some ways the Fed has met this objective by releasing their notes from their scheduled meetings on a timely basis. The challenge arises when the voting members don’t agree with each other on policy.

If you want to learn how to guage the direction of interest rates, here are some basic guidelines that I learned from Jim McMahan, a Mortgage Broker in Texas. These are some guidelines that the FED tends to follow:

1. The FED’s goal is to keep Core Inflation (C.I.) at 3% or less. (the PCE is currently at 2.16%)

2. Everytime we’ve had a recession, the FED has taken the Real Interest rate to a negative number in order to stimulate growth:

Real Interest (R.I.) rate = Federal Funds Rate (F.F.R.) – Core Inflation (C.I.)

(1.34% = 3.5% – 2.16%)

3. Real Interest rates have never increased 8 quarters in a row unless inflation (C.I.) was present at 4.5% or greater.

4. Mortgage Rates in the U.S. have been at or below 7.5%, 85% of the time in the last 80 years.

5. Mortgage rates tend to gravitate towards Core Inflation (C.I.) + 3.5% (2.16% + 3.5% = 5.66%)

If the FED continues to follow these guidelines, we could see fixed rates in the 5.6% range.

Cashflow Coach

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