Here’s your reality as a Realtor: your success isn’t just determined by taking listings, showing properties, and closing deals. Like it or not, the US economy indirectly influences your leads, sales, and ultimately income. 

This post is the next post in a series on the economics of the residential real estate market. You are going to learn what the Federal Funds Rate is, what role it plays, how it impacts inflation, and ultimately how it impacts mortgage rates. And mortgage rates are very, very important to Realtors! 

What is The Federal Funds Rate? 

Simply stated: the Federal Funds Rate is the interest rate at which banks lend money to each other overnight. But it’s not just some arbitrary figure; it’s thoughtfully (sometimes painstakingly so) set by the Federal Open Market Committee (FOMC). This body is kind of like a sub-committee within the Federal Reserve and plays a pivotal role in our nation’s monetary policy.

So the Federal Funds Rate is the baseline rate that sets the stage for short-term loans between banks. These loans, typically taking place overnight, are in many ways the foundational rate upon which all short-term debt interest rates are grounded.

How the Federal Funds Rate Interacts with Inflation

Unless you’ve been living under a rock you’ve been watching inflation spike in 2022 and start to calm down in 2023. The primary lever the Federal Reserve used to cool off inflation has been constant adjustments to the federal funds rate. Why does this matter to you?

In simple terms, inflation can be thought of as an economy that’s running too hot. When this happens, the government, armed with its monetary tools, steps in to cool things down. By tweaking the federal funds rate, borrowing becomes more costly. If banks now have to lend at, say, 5.25% (today rate) instead of their earlier 0.5% (where we were about two years ago), they must increase their lending rates to their customers (like your potential homebuyers) to remain profitable. This has a domino effect on various sectors, from car loans to credit cards, resulting in a higher cost for borrowing. The outcome? Both consumers and businesses cut back on spending, which then cools off the economy. As the economy cools, demand for goods and services contracts, and the prices of goods and services are reduced to maintain demand. As prices drop, inflation drops.

How Does This Impact Mortgage Interest Rates?

Here’s where it gets interesting for you as a Realtor. The connection between the federal funds rate and mortgage interest rates is important to understand.

The first thing to clarify is that the Federal Funds Rate primarily deals with short-term rates. However, it has ripple effects for long-term rates. If short-term borrowing becomes pricier, long-term borrowing typically follows suit. Those 30-year mortgage rates that your clients are eyeing are closely linked to a different debt instrument: the ten-year treasury bond. As these bond rates increase, typically due to increases in the short-term Federal Funds Rate, so too do the 30-year mortgage rates.

In essence, any surge in the federal funds rate indirectly touches the ten-year treasury bond, which then shows up in 30-year fixed mortgage rates.

Confidence & Competence 

Consumers are attracted to confidence and competence when selecting their Realtor. This economic series is designed to help you grow your confidence and competence when discussing the economic drivers of our industry. Check out our other blog posts on GDP, Unemployment, and Inflation. 

While economics isn’t exactly thrilling content, it *is* important to understand the influences at work in our industry and ultimately on our incomes! Kudos to you for taking the time to level up your economic game today!