At this week’s meeting, the Fed raised the outlook for rate hikes in the future. As widely expected, the Fed raised the federal funds rate by 25 basis points. However, this reflects negatively for mortgage-backed securities.
Fed Raised the Outlook for Rate Hikes in the Future
With the Fed raising the outlook for rate hikes, they now forecast three rate hikes in 2017. As a result, the Federal Reserve increased its 2017 rate hikes by one. Overall, the faster rate hike pace holds a negative impact against mortgage rates.
In general, the Federal Reserve raises the federal funds rate to balance inflation. By the Fed raising the outlook, it is assisting in keeping inflation from rising above the Fed’s target of 2%. Normally, this represents a positive outcome for mortgage rates.
Relationship with Mortgage Rates
As the Fed raised the outlook for future rate hikes, analysts look to mortgage rates for their reaction. Analysts attribute the adverse reaction to the Federal Reserve’s relationship with mortgage rates. Generally speaking, the Federal Reserve directly affects mortgage rates. As a matter of fact, the Federal Reserve owns over $1.7 trillion of the agency mortgage-backed securities (MBS). It purchased these mortgage-backed securities during its quantitative easing (QE) days.
To replace mortgage-backed securities that pay off, the Federal Reserve buys additional mortgage-backed securities. This maintains the overall balance. Currently, the Federal Reserve maintains its status as he buyer of approximately 25% of all newly issued mortgage-backed securities.
By increasing the demand for mortgage-backed securities, the Federal Reserve drives MBS prices higher. Also, mortgage rates decline.
Looking Ahead as Fed Raised the Outlook for Future Rate Hikes
In conclusion, the Fed says that it will not allow its holdings of mortgage-backed securities to decline until “normalization of the level of the federal funds rate is well under way.” While it is challenging to determine when that will be, the sooner the Fed raises the outlook for future rate hikes, the sooner the demand for mortgage-backed securities will decline.
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