They do this by offering a variety of "instruments" (also called "product") with differing structures of risk and return over given periods of time. Why?
It also impacts the cost of funding for the banks.The RBA's objective is to promote a stable currency, full employment and economic prosperity, ensuring that price growth, or inflation, remains relatively low and stable.Its 'monetary policy' involves either raising the cash rate to try and slow the economy down, or lowering it to promote economic growth.The RBA's decisions are based on indicators including employment, inflation, gross domestic product, consumer and business confidence and the housing market.If the economy is growing too fast it can lead to high inflation, while weak economic growth can lead to unemployment, reduced incomes and lower living standards.The RBA also looks at important international factors that will drive the performance of the Australian economy, in particular demand for and the price of Australia’s natural resources.If Australia’s trading partners are growing strongly and demand and prices of raw materials are rising, this can lead to strong economic growth in Australia and push interest rates higher.If commodity prices and demand for our natural resources fall, this could point to slower growth in the future and lower interest rates may be necessary.The RBA board meets 11 times a year on the first Tuesday of each month, except in January. We'll leave that for another article.The end result is that the Fed raises or lowers interest rates to help address increases or decreases in economic activity. There are many kinds of bonds available, and mortgage rates (yields) rise and fall with those competing investments to a greater or lesser degree.But how to price them? And let's say that it's a good deal, so ten investors start offering you more than the $1,000 you want. Then, the interest rates started hardening from the year 2006. You (or your investment advisors or fund managers) will only buy so many low-yielding bonds (mortgage or otherwise), because you'll take your money elsewhere if your returns are too low.Investor demand for a given kind of investment plays a considerable role in moving market yields, because investors have literally hundreds of places to put their money. At that time, the Fed made one more change, and said that in order to gradually change its mix of holdings to 100% Treasuries it would use inbound proceeds from its mortgage holdings to buy only Treasuries.It was expected that the Fed would then remain away from direct manipulation of mortgage markets, preferring to influence economic trends by moving the federal funds rate only. In particular, policymakers would like to understand how a change in short-term rates will affect medium-term and long-term rates, because these latter rates determine the borrowing costs people and firms face, which, in turn, determine aggregate demand in the economy. Is it a secret conspiracy?The answer is that rates are moved by a number of related factors, and believe it or not, you -- Joe or Jane Consumer -- are one of those factors.Mortgage money can come from many sources, including deposits at banks and brokerages, but most comes from investors through what is collectively known as the "capital markets."
This program ended in a gradual tapering of purchases before coming to conclusion in October 2014, but the Fed decided to keep reinvesting inbound proceeds from maturing and refinanced holdings and indicated that they would until "policy normalization is well under way."
Note: This is a very simplified discussion of a very complex topic. Conversely, an outlook which suggests higher inflation ahead will see mortgage rates rise, sometimes very quickly.Also, a poor economic climate affects mortgages much more profoundly than Treasuries. Money shuffles from place to place in search of this -- from bond to bond, and market to market.As we mentioned, the relationship isn't a fixed one, but one that changes with market conditions. An adjustable-rate mortgage will have its interest rate reset on a regular basis, typically once a year. They bid the price up to $1,010 -- $1,020 -- $1,030. In effect, that increase in price is actually borrowing from the interest which the bond will return. Professional money managers, and investment and retirement funds constantly strive to obtain high-yielding instruments at a given level of risk. The Economy. It goes without saying that these 'spread' relationships vary by mortgage product and also by whether a loan will be held in a lender's portfolio or sold to other entities.All of the above text assumes for the most part that we are in a fairly normal marketplace.
For example, you might have to sell that $1,000 for only $980; and the return to the investor (yield) rises, since the buyer not only gets all the interest on $1,000, but also got a discount on his purchase price.The principle to remember is this: as a bond price rises, its yield falls, and vice-versa.Mortgages are priced for sale to attract investors who seek fixed income investments. Sometimes, a minor increase in bond yields in the morning is followed by a minor decrease in the afternoon, while mortgage rates remain the same all day.There's also the impact of inflation, which affects both Treasury, mortgage and other fixed-income investments. Suddenly, the Fed was thrust back into being the lender of last resort again, and in rapid succession moved from not buying bonds at all to offering to buy $500 billion of Treasuries and $200 billion of MBS to calm roiling markets... and promptly ran through those funds in a matter of days. A soft interest rate regime started towards the early part of this decade.
(For more on this, A good way to keep a handle on the Fed is to remember that the Fed Funds rate is the shortest of short-term rates -- literally, an overnight loan -- and a fixed-rate mortgage is all the way at the other end of the scale, a loan that lasts as long as 30 years.From Fed Funds moves, there's a complicated discussion of monetary policy about how Fed moves affect certain deposit and loan markets and inflationary expectations.