It was the move that was supposed to spell the end of low mortgage rates. So why did mortgage rates barely react?
On Wednesday, December 18, the Federal Reserve announced that it was going to start scaling back on its extraordinary measures to drive long-term interest rates down. These measures, which have included huge monthly purchases of mortgage-backed securities, have been instrumental in bringing about the record low mortgage rates of recent years.
Since Fed policy has been largely responsible for those low mortgage rates, it would be easy to assume that a change in that policy would send mortgage rates higher. However, in the week following the Fed's announcement, 30-year fixed mortgage rates rose by just one basis point (one one-hundredth of a percent). Could it be that the Fed's policy was not such a big deal after all?
Fed Policy Is Yesterday's News
The fact is, Fed policy has been vitally important in bringing about the low interest home loans that have helped shore up the housing market and the economy in general. However, the change in Fed policy was met by a shrug rather than a surge in mortgage rates for three reasons:
1. Financial markets are anticipatory. The Fed has been talking about tapering off from its interest rate stimulus for several months. People making financial decisions, whether it is a bond trader buying Treasury securities or a mortgage lender setting home loan rates, try to anticipate what the future will bring. Though people did not generally know when this change in Fed policy would come about, they have known it was coming for months. That is why mortgage rates started rising months ago. According to mortgage finance company Freddie Mac, 30-year fixed mortgage rates started rising back in May, and got to roughly their current level around mid-year. In short, reaction to the December 18 announcement was minimal because it was not much of a surprise.
2. The change in Fed policy was minute. The Fed had been buying $40 billion of mortgage-backed securities and $45 billion of Treasuries every month. It is now cutting each of those totals by $5 billion. This was a much smaller, more incremental change than many people had expected, making it as much of a non-event as possible.
3. Extraordinary stimulus measures are still being applied to mortgage rates. Even with the policy change, the Fed will be purchasing $35 billion of mortgage-backed securities and $40 billion of Treasuries every month. That still represent introducing a significant amount of artificial demand into the bond market, something that helps keep interest rates low. In short, an incremental change to the policy does not alter the fact that the policy still represents an extraordinary effort to keep interest rates low.
Given the anticipatory nature of financial markets, the important question is what will happen next. The Fed's recent announcement represents just the first step in walking back from its long-term interest rate stimulus. How quickly it takes the subsequent steps, and whether those steps are any bigger than this first one, depends a great deal on the pace of progress in the economy.
On that note, it was an announcement two days after the Fed's announcement that might really hold some significance for mortgage rates. The Bureau of Economic Analysis revised its estimate of third quarter economic growth upward, to a 4.1 percent annual rate. If the economy continues to strengthen, it will both hasten the tapering off of the Fed's bond purchases and create new loan demand. Both of those reactions will put further upward pressure on interest rates.
Low mortgage rates have benefited both home buyers and sellers, as well as those who have continued to own their homes. Low mortgage rates have made buying less expensive, they have boosted home prices, and they have allowed millions to refinance a mortgage and save money. All of those parties therefore should have an interest in what happens to mortgage rates next. Watching for further signs of strength in the economy, particularly employment growth, should tell more about where mortgage rates are heading than the next Fed policy announcement.