Federal Reserve Chairman Ben Bernanke said that its quantitative easing program could slow this year if unemployment and inflation reach certain levels.
Under a “moderately optimistic forecast”, Bernanke said that the Fed would begin to “taper” its monthly MBS purchases as early as the end of 2013 if unemployment fell to 6.5% and inflation reached 2%.
Under those conditions, the program could be phased out by late 2014, he said.
In response to a CNN correspondent’s concerns that the mortgage market was relying too heavily on both the Federal Reserve and the government sponsored entities, Freddie Mac and Fannie Mae, Bernanke said that he believed the market was, nevertheless, functioning well.
“We are legally allowed to buy and sell [MBS] securities and this has contributed to lower interest rates and a stronger housing market,” he said.
It is still being debated, however, whether or not the GSE’s will remain the number one backstop to the mortgage market and what the mortgage market will look like if the government changed the housing market's structure, he said.
Some have said that without the support of the government and the Fed, there would no longer be a 30-year mortgage, the CNN correspondent mentioned.
Bernanke's signals that the Fed would decrease the level of bond purchases this year caused bond prices to tank, according to Brian McNee, vice president and senior bond analyst with MBS Authority
As widely expected, the Fed did not touch their key interest rate in the policy and economic outlook statement this afternoon, but the market did react.
Both U.S. Treasuries and Mortgage Backed Securities sold off -64BPS when the Fed Statement was read this afternoon, according to McNee.
To illustrate that the Federal Reserve was ready to start to pull back on bond purchases by the end of 2013, Bernanke used the analogy of driving a car and pressing your foot on the accelerator to make the car go faster, McNee said. He suggested still pressing on the gas pedal but not as hard. This clearly demonstrates their desire to continue to make monthly bond purchases but at a lower level than the current US 85 billion.
He also pointed out that the economy is doing better, the housing market is doing better and the job market is averaging 200K non-farm payroll jobs per month. The Fed also lowered their forecasts for inflation.
The bottom line is that in the near future, McNee said, the Fed will be less of a player in the bond market and that means less artificial demand which in turn will drive up mortgage rates as the market begins to function on its own.