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Mortgage Rate Outlook: Rates Drop After Federal Reserve Inaction

By now you may have heard the news: the Federal Reserve will continue with its quantitative easing (QE) program in full, buying $85 billion per month in U.S. Treasury bonds and mortgage-backed securities (MBS).

You can read our full news article here: “No Tapering. Federal Reserve Continues Stimulus Program in Full, Mortgage Rates Drop“.

The FOMC has used the stimulus program to “grease” the economy and accelerate the housing market recovery. In the third iteration of QE, the Fed added $40 billion in MBS purchases per month, which put downward pressure on mortgage rates and helped the 30-year fixed reach the lowest levels on record in late-2012.

Though many watchers had expected the FOMC to reduce its stimulus spending (“taper”), the committee voted to continue in full, citing concerns about the strength of the labor market. The FOMC statement also listed government fiscal policy as a possible hiccup to the recovery, which includes austerity budget cuts and gridlock over raising the debt ceiling.

Markets had already began to price in a September “taper”, so when the contrary was announced, stocks, bonds, and mortgage rates moved to adjust.

The Dow Jones Industrial Average and the S&P 500 both reached record-high closes, the bond market improved, and mortgage rates dropped.

As a major player in MBS market, the Fed is able to effect mortgage rate movement. Mortgage-backed securities have a market “price” for investment and a “yield” (pay-out) to entice investors. When the price to purchase a MBS rises, the yield drops – investors are paying more for the product, and so take home (“yield”) less.

Mortgage rates are correlated to that “yield.” When the MBS market is active and the yield drops, so do rates. The Fed helped bring borrowing rates down, but when markets got wind of possible “tapering”, they moved to adjust future expectations. Evidence of this process comes from the July FOMC meeting, after which Fed Chairman Ben Bernanke stated that the Fed would “taper” QE as the economy improved. Markets viewed this statement with alarm.

At the time, we worried that higher rates would reduce affordability and cut into the housing market recovery. We wondered why markets interpreted Bernanke’s comments so aggressively – Bernanke had always said “look to the data” and we didn’t think “the data” was good enough to risk a housing market relapse.

As it turns out, the data wasn’t good enough. Now it looks like QE could continue in full through 2013 and into the new year.

For mortgage rates, this means a downward adjustment. The “cost” for a 30-year fixed has dropped by about 1.000% (100 basis points) since Wednesday. In dollar terms, we estimated that this cost improvement brought down the expected monthly payment by about $30.

What does this mean for the future of mortgage rates? We will borrow from our recap article:

“The markets will now begin to speculate if December will be the taper meeting,” said Podesto.

The FOMC will “closely monitor… economic and financial developments in the coming months,” according to its policy statement. It will “continue its purchases… until the outlook for the labor market has improved substantially in a context of price stability.”

The Fed’s MBS purchases will continue to put downward pressure on rates, but the ultimate reduction of QE will keep mortgage rates from reaching the record-low levels from earlier in the year.

“I think rates will continue to ease in the upcoming weeks, but not back to May or June levels,” said Podesto. ”We are going to taper at some point, and the markets are prepared and have priced in that event.”

See here for September 23 mortgage rates.

Written by Central Coast Lending - Go to Central Coast Lending's Website/Profile