THE BASIS POINT

Mortgage Rates Drop On Fed Surprise

Below is the statement from today’s first Fed rate policy meeting of 2012. One surprise: they’re keeping overnight bank-to-bank Fed Funds Rates exceptionally low “at least through late 2014” instead of the previous “mid-2013” statements. The Fed Funds Rate is currently targeted between 0 and .25%.

The Fed will also continue Operation Twist to shift their debt holdings from shorter into longer durations, and continue reinvesting proceeds from their existing mortgage bond holdings into new mortgage bonds, which helps keep mortgage rates low.

I explained why this strategy keeps rates low when they announced it in September. Read it here.

The Fed didn’t explicitly confirm rumors about QE3 to buy more mortgage bonds this year.

Mortgage bonds (FNMA 3.5% coupon) rallied big on the news, closing up 39 basis points at 103.05.

Rates drop when bond prices rise like this, and vice versa.

If this mortgage rally holds or expands tomorrow, rates will reclaim record lows of 3.75% 30yr fixed single family home loans to $417k with zero points. Coming into today, rates were slightly higher at 3.875%.

Markets digested 3 housing reports today, plus we’ll get December new home sales tomorrow and 4Q2011 GDP Friday.

Here’s a preview of each item with rate impacts:

Tomorrow’s December’s New Home Sales estimates call for 310k-320k. November’s new home sales were 315k (annualized), 1.6% better than October, 9.8% better than year ago. This was the best since April, but well below the 700k needed for a healthy market, and 2011 looks to be the worst year ever for new home sales—we’ll also get the full 2011 number tomorrow. Average November new home sale price: $242,900. Rates would rise slightly new home sales was an upside blowout but that’s unlikely.

Friday’s first of three 4Q2012 GDP readings estimates call for 3% to 3.2%. The third and final 3Q reading was 1.8% after being cut twice: second reading was 2%, first reading was 2.5%. These cuts were a common pattern for 2011 GDP. But if we’re at the high side of estimates, rates could give up today’s gains as mortgage bonds sell on the initially positive perception.

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January 25 FOMC Statement (first 2012 Fed meeting)

Information received since the Federal Open Market Committee met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth. While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed. Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee’s dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate.