Q:

How does the Federal Reserve System affect seven-year mortgage rates?

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Quick Answer

Federal Reserve actions affect seven-year mortgage rates by influencing the shape of the yield curve, which tracks the relationship between interest rates that lenders charge for mortgages of varying maturities, explains Bankrate. This means, for example, that the Federal Reserve can engineer a drop in seven-year mortgage rates by purchasing seven-year securities. In addition, the organization's actions can influence auto loan rates, credit card rates, certificate of deposit rates and retail prices.

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Full Answer

The yield curve tracks the interest rates or yields of bonds having equal credit quality but differing maturity rates, notes Market Realist. To investors and economic policy makers, the shape of the curve serves as a portent of future economic activity and interest rate changes. A gradually rising curve reflects positive investor sentiment, while a steep curve predicts the start of a bull market. A flat or bumped yield curve signals investor uncertainty about the future, while an inverted curve predicts a bear market.

The Federal Reserve uses monetary policy to influence the shape of the yield curve and investor expectations, reports Market Realist. An expansionary monetary policy involves rapidly increasing money supply by lowering interest rates in order to stimulate the economy, causing the yield curve to gradually or sharply rise upwards. A contractionary monetary policy either slows or reverses money supply through a rise in short-term interest rates, causing the yield curve to flatten or invert.

When the Federal Reserve increases or decreases benchmark interest rates, other lenders follow suit, according to Bankrate.

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