We Have Liftoff

March 18, 2022

Last Week In Review: We Have Liftoff

Interest rates hover near three-year highs as the Federal Open Market Committee (FOMC) raised the Federal Funds Rate by 0.25%. This was the first rate hike in three years. Let’s break down what the Fed said in their Statement and press conference and look at what the future may hold.

“The Committee seeks to achieve maximum employment and inflation at the rate of 2% over the longer run. With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2% objective and the labor market to remain strong. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting.”…FOMC Statement March 16, 2022.

So, the Fed raised rates by .25% and said there will likely be more rate hikes to follow at some point in the future. Additionally, they expect to begin reducing its holding of agency mortgage-backed securities at a coming meeting. What does it all mean?

The Fed rate hike and subsequent rate hikes will have no direct effect on mortgage rates. Fed rate hikes only affect short-term loans like autos, credit cards, and home equity lines of credit.

If the economy is strong enough to absorb six more rate hikes this year, which is the current forecast, then we should expect long-term rates like mortgages and the 10-year Note yield to move higher.

Fed Chair Powell in his post statement press conference said multiple times, the economy is strong enough to absorb multiple rate hikes and there is no threat of a recession.

Time will tell whether the Fed will be able to raise rates that many times. Back in 2018, when Consumer Sentiment was at a 20-year high, the Fed raised rates four times and ended up cutting rates in 2019. Now in 2022, we are led to believe the Fed has the room to hike rates seven times, despite consumer sentiment hovering at 11-year lows and recessionary levels.

“We will take the necessary steps to ensure that high inflation does not become entrenched. We’re fully committed to bring inflation back down. High inflation takes a toll on everybody” Fed Chair Jerome Powell.

Part of the “necessary steps” may be for the Fed to shrink their balance sheet and more specifically, remove their holding of mortgage-backed securities (MBS). Currently, the Fed has about $2.7T worth of MBS on its balance sheet.

Here’s how the Fed explained it to us back in January and how they intended to reduce their MBS holdings.

“The Committee intends to reduce the Federal Reserve’s securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA).”

This means when mortgages are paid off through maturation, moving, or refinance – the Fed will no longer use those proceeds to purchase more MBS. This is important because if the economy is strong enough for the Fed to do this, then we should expect mortgage rates to increase over time as the Fed goes from being a buyer of mortgages to a seller of mortgages.

What is the bond market saying?

If you look at the spread between the 2 and 10-year Note yields … it is just 20bp. The last time it was this narrow, the Fed was CUTTING rates six months later. History has shown that almost every time the 2-year yield inverts or moves higher than the 10-year yield, it precedes an economic recession.

The good news? The Fed knows this and is watching the market’s reaction very closely as they did back in 2018. Fed Chair Powell also said numerous times they will take action carefully to avoid pushing the economy into a recession. The rest of this year will be volatile as the bond market reacts to economic reports and how it will influence Fed rate hikes and the potential balance sheet reduction activity.

Bottom line: Fed Rate hikes have no direct impact on mortgage rates. So, despite the Fed raising rates by .25%, home loan rates remain stable for now. If you, a family member, or a friend is considering a mortgage, now is a great time as rates remain just beneath the 2022 peaks.

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