There are several big picture factors which are viewed as negative for long-term bond yields, but investors have been aware of them for months. It’s not unreasonable that mortgage rates have climbed to the highest levels in four years. What’s harder to figure out is why the increase took place over the last couple of weeks without any significant fresh news. First, the supply of bonds issued by the Treasury is increasing due to larger government deficits resulting from policy changes. Yields generally need to rise to entice investors to purchase additional bonds. Second, the new policies potentially will lead to faster economic growth, which could increase future inflationary pressures. Finally, investor expectations for the pace of tightening by the Fed have increased. Investors now assign roughly a 50% likelihood that the Fed will raise the federal funds rate four times in 2018, up from very low levels at the start of the year. In addition, the Fed is reducing its enormous holdings of Treasuries and mortgage-backed securities, which adds to the supply of bonds.
In her semi-annual testimony to Congress, Fed Chair Yellen said that the Fed expects that economic progress will call for "further gradual increases" in the federal funds rate. She also said that it would be "unwise" to wait too long to hike rates. Yellen later added that the Fed will consider in coming months when to begin to reduce the Fed's holdings of MBS. Of note, she said that the Fed will not sell MBS to shrink the holdings, but rather will stop replacing principal reductions. The expected pace of tightening by the Fed increased a little after her testimony, causing MBS to decline.
As widely expected, the Fed raised the federal funds rate by 25 basis points. Unfortunately for MBS, Fed officials also raised their outlook for the pace of future rate hikes. They now forecast three rate hikes in 2017, one more than previously projected. The faster pace was viewed as negative for mortgage rates. But why? The purpose for raising the federal funds rate is to keep inflation from rising above the Fed's target of 2%. This should be a good thing for mortgage rates. Part of the reason for the adverse reaction stems from a more direct effect the Fed has on mortgage rates. The Fed owns over $1.7 trillion of the agency mortgage-backed securities (MBS) that it purchased during its quantitative easing (QE) days. The Fed keeps the balance of MBS around that level by buying new MBS to replace that which pays off. The Fed is currently the buyer of approximately 25% of all newly issued MBS. This added demand from the Fed drives MBS prices higher and mortgage rates lower. The Fed says that it will not allow its holdings of MBS to decline until "normalization of the level of the federal funds rate is well under [...]
This week, a major influence on U.S. mortgage rates will be the “Brexit vote on Thursday. It is very difficult to predict the effect on the global economy if the UK were to leave the European Union or whether it would lead to similar votes in other countries. Due to the economic uncertainty which would result, a vote for the UK to exit the EU is expected to be positive for U.S. mortgage rates, while a vote to remain would be negative. As each new poll shifts the odds, investors react immediately. This increases daily volatility, as investors factor the expected outcome into asset prices. For example, the latest poll showed greater support to remain, and mortgage rates have moved higher today.
After holding the federal funds rate near zero for seven years, the Fed announced a rate hike of 25 basis points, as widely expected. This was the first rate hike since June 2006. Investors are now asking what the pace of future rate hikes will be. According to the Fed statement, Fed officials expect that economic conditions will warrant only "gradual" increases in rates. The statement also noted that the Fed does not expect to reduce its holdings of MBS and Treasuries any time soon. Investors were pleased that the Fed does not appear to be in any rush to tighten monetary policy, and MBS prices and stocks moved a little higher. Want to see live MBS prices on the go? Check out the new look of www.mbsquoteline.com from your mobile device. All features optimized for your device. | Questions call 800-627-1077
Fed day is coming up on Thursday. The Statement will be released at 2:00 ET, and Fed Chair Yellen’s press conference will follow at around 2:30 ET. Fed members appear divided about raising the federal funds rate at this meeting. Investor expectations are mixed as well. With no apparent consensus, whatever the Fed decides will likely cause a significant reaction in the markets. More important than the decision about hiking rates may be what investors learn about the Fed’s view of the economy and how that may influence future Fed policy. What impact will this Fed meeting have on mortgage rates? The answer is not at all clear. It will depend on how the Fed’s decision and comments alter investors’ outlook for future Fed policy.
The Wall Street Journal reported that during tomorrow's European Central Bank (ECB) meeting the executive board of the ECB will recommend to the entire 25-member governing council a plan to begin a sovereign bond purchase program. The plan, which would be similar to the quantitative easing (QE) program used by the US Fed in recent years, would call for purchases of 50 billion euros (about $58 billion) per month for a minimum of one year. These figures are roughly in line with investor expectations, and the reaction in MBS markets has been small so far. If the governing council adopts this plan tomorrow, the impact on MBS may be small.
The FOMC statement and Fed Chair Yellen's press conference has created some volatility, but resulted in just a small net reduction in MBS prices. The statement included some change in language but Yellen pointed out that it did not "signify any change" in the Fed's "intentions" for monetary policy as indicated in prior statements. The phrase "considerable period" remained in the statement, and the term "patient" was added to describe the Fed's attitude in changing monetary policy. The forecasts from Fed officials for the pace of future fed funds rate hikes were lowered a little from their forecasts at the September meeting. Yellen said that the Fed is unlikely to start raising the fed funds rate for "at least the next couple of meetings". The Fed's view is that the economy is improving and that the slack in the labor market is diminishing. According to the Fed, the downward pressure on inflation from lower oil prices is "transitory" and will have little impact on long-run inflation levels. Yellen emphasized that future monetary policy will remain heavily dependent on incoming economic data.
One reason that mortgage rates are so low is the expectation that the ECB will begin to buy sovereign bonds, similar to the recently completed US quantitative easing (QE) program. Economic growth in Europe has stalled, and QE is one of the most powerful tools available to the ECB to help boost growth. The expected added demand for bonds from the ECB has caused bond yields around the world to decline. However, ECB officials are divided about QE, and the decision keeps getting pushed farther into the future. Notably, the Germans are opposed. At Thursday's press conference, ECB President Draghi appeared to take another small step in favor of QE. Draghi said that the ECB intends to increase the size of its balance sheet and that it would do so even without unanimous consent. However, he also deflated hopes for quick action by saying that the ECB would not consider QE until the end of the first quarter of 2015. The net impact of his comments was a small improvement in mortgage rates.
The Fed will end its Treasury and MBS purchases next month, but the impact on mortgage rates likely will be small. Over the last few years, these bond purchases, known as quantitative easing, helped push mortgage rates down to the lowest levels in decades. Mortgage rates then moved off their historic lows in May of last year when the Fed unexpectedly announced that it would soon taper the bond purchases. Since then, the decreases in monthly purchases have been anticipated far in advance by investors, causing little market reaction. As a result of quantitative easing, the Fed was the eventual investor in the majority of all mortgages originated during the bond purchase program. The Treasury and MBS purchases have caused the Fed’s balance sheet to expand to roughly $4.4 trillion dollars from less than $1.0 trillion in 2007. While the Fed will no longer purchase additional bonds, it will hold the size of its portfolio steady by reinvesting maturing securities. Eventually, though, Fed officials intend to reduce their holdings of MBS. Investors will be looking for hints about the timing for the Fed to begin to shrink its portfolio and for the pace at which it will occur. The [...]