There is a common misconception about mortgage interest rates and how rates are determined. It’s common for many people to mistakenly think The Federal Reserve sets mortgage interest rates. The media also tends to talk about mortgage interest rates in terms of the 10-Year Treasury Note. Neither of those notions are true. 
Mortgage interest rates are based on the buying and selling of mortgage-backed securities (MBS), which are an asset-backed security that is secured by a mortgage. Mortgage-backed securities are traded in the secondary market where lenders as well as private and public investors buy and sell every day.
Unlike mortgage-backed securities, the 10-Year Treasury Note is backed by the full faith and credit of the U.S. government instead of mortgages. Most of the time, the 10-year and MBS will trade in the same direction, but that’s not always the case. They are both a type of bond – competing for the same investment dollar.
The Federal Reserve sets the Fed Funds Rate (FFR). The Fed Funds Rate is a short-term overnight rate banks charge one another to borrow money. This rate is not tied directly to mortgage interest rates.
How Mortgage-Backed Securities (MBS) Work
Once loans are originated, closed, and funded they are packaged into MBS and sold to public and private investors. These investors include Fannie Mae, Freddie Mac, pension funds, insurance companies, mutual funds and hedge funds. If you have a 401K, it is possible that your fund holds mortgage-backed securities in its portfolio.
Mortgage-backed securities are traded much like stocks. As mortgage-backed securities are sold off mortgage rates tend to rise. When buyers come into the market, prices are pushed higher and mortgage rates begin to improve.
Influences to Mortgage-Backed Securities Prices
There are six primary factors that influence traders to buy or sell mortgage-backed securities, thus causing mortgage rates to rise and fall. These factors are:
- Economic data
- Stock Market
- Federal Reserve
- Geo-political News
- World events
- Inflationary Pressure
Mortgage bonds react to the news, both good and bad. In the absence of economic, geo-political, and world news, bonds will respond based on technical factors which are watched closely by analyst and traders. Mortgage rates move throughout each day and are established through the buying and selling of mortgage-backed securities.
#1 – Economic Data
Economic news and reports come on a wide variety of topics ranging from employment to housing, retail sales to gross domestic product, and everything in between. The reports are released at different times and intervals – some weekly and others are monthly. The biggest impacting economic report is the monthly non-farm payroll report, widely known as the Jobs Report. 
The Jobs Report is delivered the first Friday of each month by the Bureau of Labor and Statistics. It is chock full of data that identifies job growth by industry and age, hourly wages, and average hourly work week. Jobs drive the economy. Jobs are necessary for the velocity of money and economic stability. As jobs improve, the economy improves and mortgage interest rates move higher. The inverse is just as true – a lack of jobs leads to a weak economy which typically helps mortgage rates improve. With any economic report, better than expected data will cause rates to move higher. Weaker reports or data that comes in worse than expected will push rates lower.
#2 – Stock Market
Since the stock market and bond market have an inverse relationship most of the time, when investors are putting money into the stock market, money moves out of bonds. This causes prices to drop which pushes mortgage rates higher. The opposite is also true.
#3 – The Federal Reserve
The Federal Reserve System and the FOMC set the Fed Funds Rate which is the overnight rate banks charge one another to borrow money. The Fed does not set mortgage rates. While the Federal Reserve does not set mortgage rates, its monetary policy has an effect on mortgage rates. When the Fed tightens the money supply it is an indication of inflation or an anticipation of increasing inflation. The tightening causes mortgage rates to move higher. When the Fed injects money into the monetary system as they have done since 2009 with the Stimulus Plan and Quantitative Easing, a looser credit environment is created. This stimulates the economy through borrowing and expansion. Lower rates are a result of expansion.
#4 – Geo-Political News
The U.S. markets are considered a safe haven for investing. When world economies are growing, tensions in the Middle East are calmed money leaves the safe haven trade of the U.S. bond market and mortgage rates move higher. When crises occur across the globe or European countries experience a weakening in their economy, as has been the case in recent years, money flows into the U.S. and specifically into the bond market. With this influx of dollars, mortgage rates move lower.
#5 – World Events
Just like U.S. events, good news is bad for mortgage bonds and rates go up. The actions of foreign central banks can impact us here at home. If rates are better in other countries, foreign investors just might pull back from purchasing U.S. Securities and invest in their home country. Less demand will lead to lower prices which means higher mortgage rates. Severe weather conditions such as earthquakes, tsunamis, and other catastrophic events can have an impact on financial conditions in the U.S. Most often during these times, money will flow into the U.S. market and mortgage rates will improve.
#6 – Inflation
Inflation is the arch enemy of bonds and the biggest influencer of mortgage rates. When inflation is present it erodes the return of the fixed-income bond. This, in turn, makes bonds unattractive to investors and money leaves the bond market. Evidence of inflation is seen in the Consumer Price Index, Producer Price Index, and Personal Consumption Expenditures. Inflation causes both prices and wages to rise and the cost of borrowing increases as well. The lack of inflation results in lower consumer and wholesale prices. Non-existent or low inflation helps keep interest rates low. While inflation is the arch enemy of bonds, and economic reports and other fundamental elements influence the direction of mortgage bonds, it is important to note – human reaction and emotion still come into play.
