In short order, 30-year fixed mortgage rates climbed from 6.15 percent (May 10) to 6.74 percent (June 24). Over the same period, one-year adjustable mortgage rates increased less, from 5.48 percent to 5.75 percent.

Yet the Federal Reserve Board's target for the Federal Funds rate has remained unchanged since June 26, 2006, when the target rate was increased from 5 percent to 5.25 percent. The Fed does not actually set the Fed Funds rate, which vacillates daily based on market forces, but it does set a target rate.

So why have mortgage rates been shooting up of late?

“It's only been over the last few weeks that we've seen this rise. Before then, we'd held pretty steady for most of the year,” says Amy Crews Cutts, Freddie Mac deputy chief economist. “There's something driving this that has the markets worried.”

Fannie Mae Chief Economist David Berson thinks he has the answer: For most of 2007, investors and analysts have been anticipating that the Federal Reserve would lower the Fed Funds target rate, with some even believing there would be two rate easings, Berson says. That would have led to decreasing mortgage rates.

But now the market has convinced itself that the Fed, facing inflationary pressure from increasing food and energy prices, will do nothing to the Fed Funds rate.

“It doesn't mean the Fed won't ease rates; it just means the market no longer thinks it will, and that has forced those long-term rates up,” Berson says.

How far up will mortgage rates go? Doug Duncan, chief economist for the Mortgage Bankers Association, said in an e-mail that he expects 30-year fixed-rate mortgages to top out “a little north” of 6.5 percent by the end of 2007. Freddie Mac's Crews Cutts anticipates 30-year fixed mortgage rates to hold at 6.5 percent through 2007, then increase to 6.7 percent in the fourth quarter of 2008. Clearly, rates already are well above their 2007 projections.

If the Fed were to raise the Fed Funds rate in an effort to fight inflation, Crews Cutts believes it would risk dragging down the entire economy.

But a recession? Mortgage rates are only one possible cause, and the risk should not be discounted, says Berson.

“With energy prices so high and the economy already growing but only slowly, significantly higher long-term rates are one of the risks that could tip the economy into recession,” Berson continues. “Whatever the cause, whether it's the Fed making a policy mistake, or energy prices spiking, or some financial crisis, the odds are somewhere between 30 percent and 40 percent, which is fairly high.”

STOPPED STARTS: After a slight uptick in April, both overall and single-family housing starts  were down in May, 2.1% and 3.4% respectively. Single-family housing starts  were down 26.0% compared to May 2006.
STOPPED STARTS: After a slight uptick in April, both overall and single-family housing starts were down in May, 2.1% and 3.4% respectively. Single-family housing starts were down 26.0% compared to May 2006.