Rates Behaving Like There’s QE3. But For How Long?

Remember this time last year when rates were dropping as Europe’s debt crisis was spiraling and the chatter about QE2 was reaching fever pitch? What happened then was that NY Fed president Bill Dudley gave a speech on October 1 that confirmed QE2 and rates hit record lows a week later, then went up a bit. Then when the QE2 announcement actually came November 3, rates shot up as mortgage bonds sold off because QE2 was revealed to be Treasury rather than mortgage bond buying.

The story is slightly different this time but the theme of short-lived rate lows is the same. Rates drop when mortgage bond prices rise and vice versa. Since the Fed policy announcement yesterday, mortgage bonds are hovering just below those highs set last year—this is why rates are so low. In addition to a new round of Europe debt troubles, here’s the critical excerpt of the Fed statement that’s causing this bond rally:

The Committee 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 mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

When the Fed says they’ll “review the size and composition of securities holdings and is prepared to adjust those holdings,” the markets interpret this to mean that the Fed is open to more QE, even though most know it would be a bad idea. It doesn’t matter: the trade is the trade.

For now.

It will reverse as bargain hunters redirect their attention back to stocks, bonds will drop and rates will rise.

A rate big spike is unlikely because the U.S. economy could be headed for double dip recession as all recent stats indicate. But still: it’s unlikely that rate levels of the past two weeks will hold.

Here’s my August Refi Boom Tips for consumers trying to make decisions.