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The Federal Reserve made a surprise 0.750% rate cut this morning.

Mortgage rates are falling in response, but not because of what the Fed did as much as what the Fed implied by doing it.

The chart above dated from last week and illustrates what traders thought the Fed would do to the Fed Funds Rate at its 2-day meeting January 29-30.

Note that over a two-month span, the market expectation changed. The blue line (4.250%) represents the Fed Funds Rate prior to this morning.

Two months ago, markets overwhelmingly expected a 0.250% rate cut this January (as represented by the white line). As of last Friday, they split between 0.500% and 0.750%.

When the economy is weak, this sort of shift tends to happen. It’s the same expectation of weakness that drives mortgage rates down over time, too.

This is why both the Fed Funds Rate and mortgage rates tend to fall during times of economic weakness.

So, after the Federal Reserve’s surprise move this morning, we can infer that the Fed sees dramatic weakness in the economy — enough that a half-point cut to 3.750% may have just been too little.

And this is why mortgage rates are falling this morning. Prior to today, only half of the market had expected such weakness that a three-quarter point adjustment would have been required.

This morning, mortgage markets are resetting their bets about the economy by purchasing more mortgage bonds. The added demand is causing rates to fall, but not anywhere near the three-quarter percent levels by which the Fed cut the Fed Funds Rate.

Mortgage rates are down slightly.

(Image courtesy: Federal Reserve Bank of Cleveland)

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