If you’ve been following the financial news lately, you probably noticed that the Fed cut the Fed Funds rate for the third time this year several weeks ago. We didn’t cover the news in depth because we covered the first two cuts and there was nothing new about this one.

Mortgage Rates Don’t Necessarily Follow the Fed Funds Rate

Remember, traditional mortgage rates are not determined by the Fed Funds rate, but are certainly affected by it. If you’re unfamiliar with this concept, check out our other articles on the Fed Funds Rate, especially those immediately following the two prior rate cuts:

• Why Doesn’t the Fed Lower Interest Rates to Encourage the Housing Market?
• What the Fed Funds Rate Drop Means for You
• So Did Rates Go Up or Down? Clearing Up the Confusion.

Housing’s Delicate Balance

The housing industry and the U.S. economy are balancing delicately over dangerous ground right now that could lead to recession in the near future if the Fed doesn’t play things right. The recent Fed Funds rate cut of .25% was the third this year, totaling .75% in interest rate cuts in an attempt to prevent a recession. Mortgage rates went up a bit around mid 2007, and since then, rate have come down a bit, but that wasn’t due to the Fed Funds Rate cuts; instead, the slight drop in mortgage rates was due to investors coming to terms with the market changes we saw developing around that time.

The Fed has been cutting interest rates in order to avoid a recession, but in the near future, the Fed may find itself between a rock and a hard place when it comes to options for maintaining balance in the economy. The real estate industry is still taking its fair share of punches, which threaten to affect the rest of the U.S. economy. The Fed Funds rate cuts are designed to lessen a potential disaster, but if the Fed sets its target rate too low, it risks sending inflation soaring.

Moving Forward

The Fed is unlikely to cut rates any further this year or next, but the current condition of the real estate industry may continue well into 2008. The question is, will the real estate problems we’re seeing now carry on into 2008 or even 2009? If that happens, the Fed is going to be faced with a major issue: Cut rates again and risk heavy inflation, or hang tight and risk a recession? It’s a tough call…rising inflation leads to higher mortgage rates and recession generally leads to stable or declining mortgage rates; which scenario, if any, comes to fruition remains to be seen as the effects of the interest rate cuts will take some time to work their magic on the economy.

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