What does the term structure of interest rates suggest regarding an increase in the federal funds rate?

The term structure of interest rates reflects how interest rates for different maturities relate to one another and how they respond to changes in short-term rates, such as the federal funds rate. When the Federal Reserve increases the federal funds rate, it signals a tightening monetary policy, which generally leads to rising interest rates across various maturities, including mortgage rates.

Choosing the first option aligns with the typical market behavior where mortgage rates will likely increase, but usually not in direct proportion to the increase in the federal funds rate. This is because mortgage rates are influenced by a variety of factors, including long-term economic expectations, inflation expectations, and market dynamics. Therefore, while mortgage rates will rise, they often do so at a slower pace compared to the increase in the federal funds rate. This reflects that lenders tend to anticipate longer-term economic conditions, which can moderate the immediate impact of short-term rate changes.

The other options suggest either an inverse relationship or that there is no effect on mortgage rates, both of which do not accurately capture how these rates typically behave in response to changes in the federal funds rate. Understanding this dynamic is crucial for appreciating how monetary policy influences broader economic conditions, including housing market activity and consumer behavior.