A syndicated column by Jeff Brown

When the Federal Reserve cut a key short-term rate Wednesday, many economists and Wall Streeters predicted that long-term rates would soon fall as well, driving mortgages and other loans to new lows.

But why? The fed funds rate, cut Wednesday from 1.25 percent to 1.00 percent, applies only to the most arcane of transactions - overnight loans between commercial banks drawing on reserves they have deposited with the Fed.

The Fed has good control over this rate but cannot dictate long-term interest rates, such as the 10-year U.S. Treasury bond rates that set the pace for mortgages. Long-term bond rates - more correctly, "yields" - are governed by the laws of supply and demand as investors buy and sell bonds among themselves.

Long-term rates are usually much higher than short-term ones, since investors demand higher rates to take the risk of tying up their money for long periods. Wednesday morning, for example, three-month Treasuries yielded about 0.8 percent, compared to 3.27 percent for 10-year Treasuries.

But short- and long-term rates are not entirely independent. Long-term investors have to keep an eye on short-term rates because they must constantly decide whether they are really better off in long-term bonds. In a sense, buying a long-term bond means placing a bet on the future of short-term rates.

If you thought the rate on a short-term investment such as a money market fund would rise next year to, say, 5 percent, you'd be silly to lock your money up today in a 10-year bond paying just over 3 percent.

In the same way, if you thought short-term rates would stay below 1 percent for years on end, you might be happy to get only 3 percent on a 10-year bond. If many investors felt that way, the rate on the bond would fall to 3 percent or lower.

Indeed, this is what's happening now. Fed officials sent a number of signals this spring that they intend to keep short-term rates low for some time, though they haven't said exactly how long. Investors have reacted by driving down yields on 10-year Treasuries.

They do this by bidding up prices on older bonds. A $1,000 bond yielding 4 percent would pay its owner $40 a year - and that payment is fixed for the life of the bond. If demand drove the bond price up to $1,333, that $40 would mean a yield of only 3 percent: $40 / $1,333.

How does that affect mortgages?

Most mortgages are bundled together and sold to investors as mortgage-backed securities that are similar to bonds. Each investor receives a share of the interest paid by the homeowners who took out the mortgages.

The average 30-year mortgage is retired after less than 10 years because the homeowner refinances, or sells the property and pays off the mortgage. So mortgage-backed securities compete with 10-year bonds for investors' dollars.

If the yield on the 10-year bond falls, investors will shift their money to mortgage securities that are more generous. The extra demand will cause prices of mortgage securities to rise, driving yields down close to that of the 10-year Treasury. Demand for the mortgage security will then level off, and the new rate will stabilize.

How low will mortgage rates go as a result of the Fed's rate cut Wednesday?

No one knows for sure. Since many bond investors had expected a rate cut, the forces of supply and demand may already have adjusted to take it into account.

In fact, the 30-year mortgage rate actually rose slightly last week, to 5.1 percent from 4.99 percent the week before, according to the Mortgage Bankers Association.

If the Fed rate cut is already "built into" the market, mortgage rates may not fall - not a lot, at any rate. On the other hand, until the Fed signals that a rate increase is in the offing, there's not much chance mortgage rates will go up. That probably won't happen until the economy looks like it's really perking up.

Good news if you'd like to buy a house and want to take your time.