Friday, the Federal Reserve lowered its Discount Rate by 0.50% in an effort to preserve liquidity among our nation's banks. This has nothing to do with mortgage rates that people like you and I get for our homes. Well, not directly at least.
The Discount Rate is the rate at which banks borrow money from the Federal Reserve. It is different from the Fed Funds Rate which is the rate at which banks borrow from each other.
After the adjustment last week, the Discount Rate now stands at 5.750%; the Fed Funds Rate is 5.250%. Note that the Fed "charges" more than other banks because it wants to be the "lender of last resort".
And last week, it was.
When the Fed lowered the Discount Rate Friday, it signaled that it was concerned for the nation's banks and their liquidity. A reduced Discount Rate strengthen the system by lowering bank operating expenses and increasing capitalization.
The Fed also extended its normal payback period from one day to 30 days. The additional 29 days buys extra time for banks to rebalance their books through asset sales or debt issuance.
On Friday, mortgage rates fell in response to the Discount Rate announcement, but not because the two are related.
Inflation devalues mortgage bonds and the Fed's move signals that inflation pressures may be subsiding. When the inflation is falling, mortgage bonds improve in price and these higher prices yield lower rates.
This is why mortgage rates dipped. Not because the Fed lowered the Discount Rate, but because what the lowering signaled about the economy.
