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A major factor driving
interest rates is inflation. Higher inflation is associated with a growing
economy. When the economy grows too strongly, the Federal Reserve increases
interest rates to slow the economy down and reduce inflation. Inflation
results from prices of goods and services increasing. When the economy is
strong, there is more demand for goods and services, so the producers of
those goods and services can increase prices. A strong economy therefore
results in higher real-estate prices, higher rents on apartments and higher
mortgage rates. Mortgage rates tend
to move in the same direction as interest rates. However, actual mortgage
rates are also based on supply and demand for mortgages. The supply/demand
equation for mortgage rates may be different from the supply/demand equation
for interest rates. This might sometimes result in mortgage rates moving
differently from other rates. For example, one lender may be forced to close
additional mortgages to meet a commitment they have made. This results in
them offering lower rates even though interest rates may have moved up!
There is an inverse relationship between
bond prices and bond rates. This can be confusing. When bond prices move up,
interest rates move down and vice versa. This is because bonds tend to have
a fixed price at maturity––typically $1000. If the price of the bond is
currently at $900 and there are 10 years left on the bond and if interest
rates start moving higher, the price of the bond starts dropping. The higher
interest rates will cause increased accumulation of interest over the next 5
years, such that a lower price (e.g. $880) will result in the same maturity
price, i.e. $1000. |
