What the Fed Has in Mind for Your Mortgage in 2014

As Janet Yellen went through her confirmation hearings, there was plenty of media speculation about what kind of Federal Reserve Chairman she would be, and what the transition from Ben Bernanke to her would mean for mortgage interest rates. However, the best clue about the future of interest rates came not in those confirmation hearings, but in the latest Federal Open Market Committee (FOMC) meeting minutes that were released In late November.

How the FOCM Can Ruin Your Life -- Or Not

The FOMC is the committee which decides Fed monetary policy, and the fact that it is a committee which reaches decisions by vote is one reason why Bernanke's departure and Yellen's ascension to Fed Chair will only make an incremental difference. As much as the media puts its attention on the Fed's front person, the truth is that it is a team effort and most of that team will remain unchanged.

The other reason why the change in the Chairmanship will not have a dramatic effect on Fed policy is that Yellen has been a prominent supporter of that policy, not a regular dissenter of the FOMC's decisions. When Barack Obama chose to nominate someone from within the FOMC and seemingly on board with its decisions, he was making a choice for continuity rather than change.

So, if Yellen's nomination does not hold the key to the next direction in interest rate policy, what does? Well, the most recent FOMC meeting minutes at least provide a couple clues.

The Long and the Short of Fed Policy

Those FOMC minutes show the committee to have cautious optimism regarding the progress of the economy, yet members are wary of making a change in their stimulative policies too soon. As for how such a change might occur, two interesting points emerge from the minutes:

  1. The Fed is likely to cut back asset purchases before raising the Fed funds rate. This means that long-term interest rates -- like mortgage rates -- are likely to rise before short-term rates. In bond market parlance, this means a steepening of the yield curve, as the spread between long-term and short-term rates widens. Consumers may see it more as getting a raw deal, with purchase mortgage rates, refinance rates, and home equity rates going up, while rates on deposit accounts remain mired near zero.
  2. The Fed may decide to signal its intention to cut asset purchases in advance of actually doing so. Because financial markets are anticipatory -- especially where long-term assets are concerned -- expect any definitive signal of intentions from the Fed to have much the same impact as actually changing its policy.

The outcome of these points is that short of a real setback for the economy, a rise in interest rates seems inevitable for 2014, and is likely to take place first on the long end of the yield curve, meaning mortgage rates will be among the things first affected.

What the Fed Is Watching

When the Fed decides to pull the trigger on this course of action depends largely on two things: unemployment and inflation. The Fed is looking for unemployment to continue to fall, and for inflation to remain in check. If you watch what the Fed is watching - i.e., unemployment and inflation - you should be able to track whether the plans to taper economic stimulus are likely to slow down or accelerate.

If there are any setbacks in job growth, expect it to slow the Fed's timetable. On the other hand, if inflation perks up for more than an isolated month or two, it could accelerate that timetable.

What this Means to You

The last couple years have seen a best-of-both-worlds scenario for homeowners. Low interest rates created excellent opportunities to refinance a mortgage or get a relatively cheap home equity loan, while rising home prices boosted the value of their properties. Don't expect this best-of-both worlds scenario to continue in 2014.

If the economy remains on track, expect mortgage rates to rise. A strong economy should mean that homeowners will continue to see their property values rise, but rising mortgage rates would also mean that refinancing opportunities will start to dry up, and home equity loans will become more expensive. On the other hand, if the economy suffers yet another setback, low mortgage rates may stick around a while longer, but housing values may start to fall again.

With mortgage rates starting at such a low level, 2014 probably won't be a bad time to buy a house, refinance a mortgage, or get a home equity loan. It just won't be quite as good a time for those mortgages as 2013 was.

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