The Fed's words can matter as much as its decision.
Financial markets respond not only to what the Fed does, but also to how its decision compares with investor expectations.
For example, if the market expects three future cuts but the Fed suggests only one, yields may rise. If the market expects no cuts but the Fed opens the door to two, yields may fall. If the Fed cuts rates but remains concerned about inflation, longer-term yields may still rise. And if the Fed holds rates steady but signals that the economy is weakening, yields may fall.
The market is constantly attempting to price the future, not simply reacting to today's announcement.
How bond investors influence yields.
No single investor or institution controls Treasury yields. They are established collectively through daily trading and Treasury auctions involving banks, pension funds, insurance companies, mutual funds, hedge funds, foreign governments and central banks, individual investors, and the Federal Reserve.
When the U.S. Treasury issues new debt, investors bid to purchase it. If demand is weak, the government generally must offer a higher yield to attract buyers. When demand is strong, Treasury securities can be issued at lower yields.
This is especially important when the federal government is borrowing and issuing large amounts of debt. Even if the Fed wants borrowing conditions to ease, the heavy supply of new Treasury securities can keep longer-term yields elevated.
What this means for mortgage rates.
The 30-year mortgage rate does not move directly with the Fed's overnight rate. Mortgage rates are primarily influenced by the 10-year Treasury yield, demand for mortgage-backed securities, expected inflation, economic and credit risks, lender and loan-servicing costs, and expectations for future Fed policy.
That is why the Fed can lower its rate while mortgage rates remain unchanged, or even move higher.
The easiest way to remember this is: the Fed sets the shortest-term rate, but bond investors price the future.
When Fed officials speak, the bond market is asking what inflation, economic growth, government debt, and interest rates could look like several years from now. The market's answer to that question, not simply the Fed's decision today, is what moves longer-term interest rates.
