WeeklyBasis 6/19/10: Primer On Fed Rate Strategy Before June 23 FOMC Meeting

Rate Snapshot
It’s quite surprising that rate volatility has been minimal for three weeks. As such, zero-point rates on 30yr fixed Conforming loans (up to $729k) held last week near record lows for a third straight week, and one-point rates on Jumbo loans (above $729k) remain steady in the low- to mid-5% range. Rates for each category below.

Rate Factors Week of June 21
Volatility could return with a full economic slate next week. Here’s the market moving data for the week, each noted with what impact it could have on rates:

We start with May Existing Home Sales Tuesday (rates neutral), a two-day Federal Open Market Committee meeting ending with a rate policy announcement Wednesday (rates neutral to higher), the third of three 1Q2010 GDP readings Friday (rates neutral to higher), $108b in 2yr, 5yr, and 7yr Treasury Note auctions Tuesday-Thursday (rates higher), and the House/Senate reconciliation of a massive finance reform bill will reach a critical stage as lawmakers look to finalize the bill for President Obama (rates neutral).

What The Fed Will Say Wednesday, June 23
The Fed’s FOMC meeting announcement Wednesday will likely reveal the Fed’s intent to keep overnight bank-to-bank Fed Funds Rates at .25% and overnight Fed-to-bank Discount Rates at .75%. They may also confirm whether they’ll raise these overnight rates before they’d start selling the $1.25b in mortgage bonds they bought from January 1, 2009 to March 31, 2010.

And finally, we’ll see if any FOMC members come around to Kansas City Fed President Thomas Hoenig’s way of thinking. At every FOMC meeting this year, he’s voted to start gradually hiking rates to avoid more violent rate hikes later (more on this in next section).

The Fed selling mortgage bonds would directly and immediately cause mortgage rates to rise, while the Fed hiking overnight rates would have an indirect and slower hiking impact on mortgage rates. So when they decide the economy can handle higher rates they will hike overnight rates first. Then as the recovery strengthens, they’d start selling mortgage bonds. When those bond prices drop in a selloff, mortgage rates rise commensurately.

Are Fed Rates Too Low For Too Long?
The debate today is whether Bernanke’s Fed is keeping rates too low for too long. Greenspan’s Fed did the same thing with the Fed Funds Rate from January 201 (6.5%) to June 2004 (1%), and when they did start hiking off the 1% mark, it was gradual until Fed Funds reached 5.25% June 2006. It stayed there until the financial crisis picked up steam, then the Fed cut from 5.25% in September 2007 to .25% December 2008, and it’s been at .25% since then.

Greenspan took lots of heat for leaving rates too low for too long. Bernanke is perhaps better justified since this financial crisis and resulting global economic instability is much deeper than anything Greenspan faced. But we’ve also increased the money supply drastically to combat the crisis, so if the economy does show continued signs of improvement, inflation can spike quickly. Fed rate hikes and mortgage bond selloffs would follow, both causing mortgage and all other rates to spike.

Volatility is the byproduct of markets trading on every little sign that we’re finally ready to move out of an artificially low rate era. And that’s precisely why this WeeklyBasis opened by saying “it’s quite surprising” to see less volatility in recent weeks.

It’s also why consumers waiting for lower rates will be disappointed if they wait much longer.

CONFORMING RATES ($200,000 – $417,000) – 0 POINT
30 Year: 4.75% (4.87% APR)
FHA 30 Year: 4.75% (4.89% APR)
5/1 ARM: 3.5% (3.62% APR)

SUPER-CONFORMING RATES ($417,001 to $729,750 cap by county) – 0 POINT
30 Year: 4.875% (4.99% APR)
FHA 30 Year: 4.875% (4.99% APR)
5/1 ARM: 4.25% (4.37% APR)

JUMBO RATES ($729,751 – $2,00,000) – 1 POINT
30 Year: 5.375% (5.49% APR)
5/1 ARM: 4.5% (4.62% APR)