The recently released Fed Minutes and testimony from Fed Chair Yellen have provided more detail in some areas about future Fed policy. There are two primary tools that the Fed is currently using, bond purchases and the fed funds rate.
Bond purchases from the Fed, which include both Treasuries and mortgage-backed securities (MBS), exert a direct influence on mortgage rates. The added demand for MBS from the Fed raises MBS prices. Since mortgage rates are set based on MBS prices, this helps keep mortgage rates low. The Fed’s portfolio of MBS has been growing at a scheduled pace as the Fed has been reinvesting principal payments received and adding new MBS. The Fed has been tapering its bond purchases, though, and the Minutes indicated that the purchases of new MBS will end in October as expected. After that time, the Fed plans to continue to reinvest principal payments received, which will hold the size of its portfolio steady, at least until the first fed funds rate hike. Principal payments have been averaging $16 billion per month, so investors were pleased that the reinvestment will continue for quite a while.
The fed funds rate, a very short-term interest rate, has a less direct effect on long-term mortgage rates than MBS purchases, but lower short-term rates generally help hold down longer-term rates as well. Fed Chair Yellen has provided no specific guidance about the timing of the first fed funds rate hike. She has emphasized that future policy decisions will be dependent on the performance of the economy. She expects that the economy will expand at a “moderate” pace for the next several years. Fed officials are particularly concerned with the strength of the labor market. The consensus is that the first fed funds rate hike will take place during the middle of 2015.