Where Mortgage Rates Will Go By Summer And Why

This report covers weeks 57-59 of a mortgage bond purchase program by the Federal Reserve—here’s week 56. In the last three weeks, the Fed bought $34b net of mortgage bonds as follows: $12b Jan 28-Feb 3, $11b Feb 4-10, $11b Feb 12-17. For the past 5 months, the Fed has focused weekly buying on 4.5% and 5% coupons (table below), which represent outstanding loans in the 4.75%-5.125% and 5.375%-5.75% ranges respectively. This makes sense since most of the new bond supply coming to market from new loans being made are at those rate ranges. Despite Fed buying, mortgage bonds lost ground this week and rates are higher. The selling came after higher than expected business inflation, some rate hike bias signals in Fed minutes from their last FOMC meeting, and a confirmation of that bias in the form of a .25% hike to the Discount Rate which is now at .75%. The Discount Rate is the the rate at which the Fed lends to banks, and this is the first move since the crisis began toward weaning banks off of cheap Fed funds.

How Long Will Current Rates Last?
The purpose of the Fed mortgage bond buying program initiated January 1, 2009 is to elevate mortgage bond prices which pushes rates down. It’s very likely that the record rate low markets hit on November 25, 2009 will remain the record low. The Fed will continue buying through March 31, 2010 until they reach their $1.25t budget (see program-to-date tally below), but as we move into the program’s final weeks, we’re already seeing rates rise as markets realize there will be one less large buyer of mortgage bonds.

Last week, New York Fed President William Dudley, the man who runs the Fed’s MBS program, said there could be more Fed MBS buying if the economic recovery stalled or rates spiked too much, confirming the Fed’s post-FOMC meeting comment a couple weeks ago that they “will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”

But if rates did rise, there would be less MBS supply to absorb. Also very strict loan approval standards mean that high quality loans underpin new MBS issues—so over time, private MBS markets should re-emerge as the Fed eases off. And this is the end game. There must be a private MBS market that’s not reliant on the government as a core participant.

Until we get to that stage, we can expect lots of rate volatility during 2010, and our 2010 rate outlook is for rates to rise about 1%.

What Mortgage Bond Buying Means for Rates And Consumers
We cover the Fed mortgage bond buying closely to try to help consumers make decisions but the main point is: rates are near all-time record lows, so if you can get the right price on a property purchase you’ll get a record low rate to go with it. And if you’re looking to refi, your window is closing.

In addition to our full-year rate outlook link above, this excerpt from a post we did earlier this week answers the question of where rates may go by summer and why:

Rates on loans up to $417,000 are about 5% as of mid-February, and rates could rise as much as .5% by summer for three macro reasons: (1) The Fed will end it’s $1.25t mortgage bond buying program March 31, and then we’ll likely see profit taking on mortgage bonds as private investors sell, which pushes prices down and yields—or rates—up; (2) An improving economy and resulting inflationary fear will cause mortgage bonds to sell off because inflation eats up bond returns, so this would also push bond prices down and rates up; and (3) Inflation will cause the Fed to start hiking short rates from current near-zero levels. Global investors currently borrow on these short-term rates to buy long-term securities with higher returns. When short rates rise, it will erode the benefit of this interest rate trade and force selling of long-term securities—including mortgage bonds—to repay short-term loans. That selling will also push rates higher.

Tally Of Mortgage Bonds Bought By Fed
The Fed, according to their own reporting, has bought $1.198t net of mortgage bonds, which is 95.84% of their allotted $1.25t target by March 31, 2010. This isn’t an official number, it is a close tally The Basis Point has kept of weekly net MBS purchases since the Fed began buying in January 2009. Here’s the current and detailed report of the Fed’s MBS holdings.