Why Mortgage Rates Fell BEFORE the September 18 Fed Meeting

Mortgage rates "come from" one place only: the prices of mortgage bonds as determined by investors.

The higher the price, the lower the corresponding return, or rate.

Bonds -- like stocks -- are traded as securities. An investor may buy Microsoft stock if he thought the company's future looked bright, and he may buy mortgage bonds if he expected favorable bond market conditions ahead.

In a declining economy, bonds can be an especially attractive investment because they offer a fixed rate of return to an investor. As more buyers line up to buy, of course, the price of bonds goes up.

Again, higher price = lower rate.

So, because Friday brought us a surprisingly weak job report, investors have increased their exposure to mortgage bonds, pushing prices higher and, therefore, pushing mortgage rates down.

Now, all of this is happening in advance of the Federal Reserve's meeting September 18 and that's important to recognize.

Mortgage rates, in effect, have dropped because of the market's expectation of what the Fed will do next week -- not because of something that it has done already. Markets expect that the Fed will lower the Fed Funds Rate, thus signaling that the economy is in decline.

Therefore, if the Fed's actions meet the market's expectations Tuesday, mortgage rates shouldn't move even a hair -- that "future scenario" has already been priced in. If the Fed fails to meet expectations -- on the high-side or the low-side -- mortgage rates will change.