When people hear that the Federal Reserve has raised or lowered interest rates, they often assume mortgage rates will move accordingly. However, mortgage rates are not directly tied to the Fed Funds Rate. Instead, they tend to follow the 10-year U.S. Treasury yield.

What Is the Fed Rate?

The Federal Funds Rate, often called the Fed Rate, is the interest rate at which banks lend money to each other overnight. It is set by the Federal Reserve and serves as a key tool for controlling inflation, economic growth, and overall financial stability.

Banks are required to maintain a certain amount of reserves at the Federal Reserve. When a bank falls short, it borrows from other banks that have excess reserves. The interest rate they pay on these short-term loans is the Federal Funds Rate.

The Federal Reserve adjusts the Fed Rate to manage the economy. To combat inflation, the Fed raises rates to make borrowing more expensive, slowing down spending and investment. To boost economic growth, the Fed lowers rates to make borrowing cheaper, encouraging spending and investment.

What Is the 10-Year Bond Rate?

The 10-year Treasury yield (often called the 10-year bond rate) is the interest rate investors earn when they buy a 10-year U.S. Treasury bond. It represents the return on investment for holding the bond to maturity and is a key indicator of economic conditions.

Mortgage lenders price their loans based on what investors are willing to pay for mortgage-backed securities (MBS). The 10-year Treasury yield serves as a benchmark because:

• Most mortgages are paid off, refinanced, or moved within 7-10 years, making the 10-year Treasury a closer match than shorter-term bonds.

• Investors see both Treasury bonds and MBS as relatively safe investments, making their yields move in tandem.

When Treasury yields rise, mortgage rates typically increase, and when they fall, mortgage rates tend to drop as well.

Factors That Influence Mortgage Rates

Beyond Treasury yields, several factors impact mortgage rates, including:

1. Inflation – Higher inflation erodes the value of future bond payments, leading investors to demand higher yields, which pushes mortgage rates up.

2. Economic Growth – Strong economic growth increases demand for loans, leading to higher mortgage rates.

3. Federal Reserve Policy – While the Fed Funds Rate doesn’t directly set mortgage rates, Fed policies (such as bond-buying programs or signaling future inflation concerns) influence investor expectations, affecting Treasury yields and, by extension, mortgage rates.

4. Global Markets – Investors seeking safe-haven assets may buy U.S. Treasuries, lowering yields and mortgage rates. Conversely, if global markets are strong, investors may seek higher-risk investments, pushing yields up.

5. Supply and Demand for Mortgage-Backed Securities – If investor appetite for MBS is strong, mortgage rates stay lower; if weak, lenders must raise rates to attract buyers.

This chart clearly shows the impact of Key Market/Economic events on mortgage rates via the 10 Year Treasury Note Yield. When the Fed signals that rates will remain steady, it can create more certainty in the bond markets, which could stabilize mortgage rates. If investors interpret the pause as a sign that inflation remains stubborn, it could keep Treasury yields higher, maintaining upward pressure on mortgage rates.

If you’re watching mortgage rates, keep an eye on the 10-year Treasury yield. Historically, 30-year fixed mortgage rates are usually 1.5% to 2.5% higher than the 10-year Treasury yield; a good way to estimate is by adding 2.125 spread to the current yield. While the Fed plays a role in the broader economy, mortgage rates are more directly influenced by investor sentiment, inflation, and economic conditions. Understanding these factors can help you time your mortgage decisions strategically.

This post was written with assistance from ChatGPT but reviewed and edited by a human. Additional information provided by Risha Kilaru of OriginPoint, Compass’s preferred lender.