After a wide array of economic releases, the impact saw retail sales fall short. Overall, there was no shortage of economic news.
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 [...]
A couple of months ago, Fed Chief Bernanke was answering questions about the Fed's plan to sell its MBS portfolio. He stated that the Fed would eventually return its balance sheet to normal by selling the $1.25 trillion in MBS it had bought to stimulate the economy, but that it would not take place soon. While some Fed officials were pushing for a faster start date, investors believed that the MBS sales were likely to begin early in 2011. As the economic outlook has grown weaker, however, the Fed's likely plans have changed. Rather than discussing a start date for Fed tightening moves, Fed officials are now outlining options and conditions for adding further monetary stimulus. In particular, the Fed had been planning to allow the MBS in its portfolio to mature without replacing them. Due to defaults, refinancings, and maturities, some MBS "roll off" the Fed's portfolio over time. Until recently, investors expected the Fed to let its portfolio slowly shrink in this fashion, which would represent a minor amount of monetary tightening. Tuesday, though, a Wall Street Journal article suggested that Fed officials are considering whether to replace those securities to stimulate the economy. With the next Fed [...]