A strange thing happened after the Federal Reserve lowered interest rates in September.  Mortgage rates rose.  In fact, the 30-year fixed mortgage rate is higher now than when the Fed lowered rates.  I’m not surprised.  Let me explain.

When I watched the news covering the Fed’s rate cut there was near universal belief that mortgage rates would fall.  National and local news reporters said so, too.  Upon hearing this I told my wife that rates were going to go higher.  Why?  I’ve learned that when everyone expects something then the market will almost always go in the opposite direction.

The market is a discounting mechanism.  It doesn’t price assets based on what is happening today.  Instead, it reflects what is expected to happen.  The Fed had already signaled that they were going to cut rates so they fell long before the Fed meeting.  In May the 30-year mortgage rate was 7.2 percent.  By the time the Fed cut rates in September mortgages had dropped to 6.1 percent.  Now they are 6.9 percent.  This paradox is why there is the saying, “buy the rumor, sell the news.”

What many people don’t understand is the Fed doesn’t control mortgage rates.  The Fed controls short-term interest rates, which is why money-market rates have dropped and are still falling after the Fed’s second rate cut.  Mortgage rates, however, follow long-term rates.  Long-term rates are determined by the market and reflect expectations for inflation and deficit financing.  If a Fed rate cut is seen as inflationary then long-term rates and mortgage rates will rise even as short-term rates fall.

Where will mortgage rates go from here?  There isn’t a consensus.  Famed investor Paul Tudor Jones believes increased government spending will be inflationary and that, combined with a ballooning national debt, will push rates higher.  That would be a problem for bonds, which is something we’ll need to closely watch.

Others believe mortgage rates will trend lower, but not to the 3 or 4 percent rates of the recent past.  Rates settling in the 5.5 to 6.0 percent level seem likely.

If you are looking to refinance a mortgage, I suggest using no-closing-cost refinancing.  You accept a slightly higher mortgage rate but don’t pay any closing costs.  Then whenever rates fall you can refinance again knowing that it is only costing you time and effort.  After all, no one really knows how far mortgage rates could fall. 

David Vomund is an Incline Village-based Independent Investment Advisor.  Information is found at http://www.VomundInvestments.com or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.