Economists predict mortgage rates impact amid Fed inflation plan
Mortgage rates are likely to plateau near current levels but whether or not the housing market will be “quantitively uneasy” as the Federal Reserve sheds some $35 billion in mortgage-backed securities to ease inflation will depend on the financial products’ demand, according to a pair of economists reacting to the US Central Bank’s historic moves to tame the volatile economy.
The Fed delivered the biggest interest rates hike in more than two decades while revealing it would start shrinking its massive balance sheet next month in the most aggressive tightening of monetary policy in decades in an effort to combat soaring inflation. To that end, the central bank’s policy-setting Federal Open Market Committee (FOMC) on Wednesday unanimously voted to increase the benchmark rate by a half percentage point. In tandem, it will begin allowing its holdings of Treasuries and mortgage-backed securities to decline in June at an initial combined monthly pace of $47.5 billion, stepping up over three months to $95 billion.
“The Federal Reserve raised the Federal Funds rate by a half-percentage point, the largest increase since 2000,” First American deputy chief economist Odeta Kushi explained. “The Fed will also shrink its balance sheet, starting in June, by allowing securities to mature without reinvestment.”
But whether or not the housing market will be “quantitatively uneasy” with allowing $35 billion in mortgage-backed securities to run off the balance sheet each month remains an open question, the economist told Mortgage Professional America. The tactic “will depend on mortgage-backed securities demand, which will dictate whether mortgage rates go up much more,” she said.
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While the Federal Reserve does not determine mortgage interest rates, their movement closely aligns with the Fed’s policy actions. Starting in June, the Fed will let $30 billion in Treasury debt and another $17.5 billion mortgage-backed debt expire each month through August. According to the plan, the Fed by September will double the amount of debt it lets expire each month to $60 billion in Treasury debt and $35 billion in mortgage-backed debt.
“The message is clear,” Kushi said in response to the plan. “It’s imperative to get inflation under control, and the Fed will act aggressively to do so.”
Mike Fratantoni, senior vice president and chief economist at the Mortgage Bankers Association, was less bullish on the balance sheet plan, suggesting the unknown results may inadvertently exacerbate volatility in the mortgage-backed securities market.
“As clearly signaled in the March minutes, the FOMC will move to allow $60 billion in Treasuries and $35 billion in MBS to passively roll off the balance sheet each month, gradually reducing these asset holdings from extraordinary levels,” Fratantoni said. “The runoff will ramp up over the course of three months, which should allow markets to absorb this excess supply. Importantly, neither the statement nor the balance sheet plan repeated the goal of returning the balance sheet to all Treasuries, and there was no mention about the potential for active MBS sales. Musing about active sales has likely increased volatility in the MBS market recently, as investors do not know how to interpret the vague signals that had been given.”
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Taking in the developments at the central bank, Fratantoni made a prediction related to mortgage rates and the future of refinancing: “MBA is forecasting that mortgage rates are likely to plateau near current levels,” he told MPA. “The financial markets have attempted to price in the impact of Fed actions over this cycle, and they are likely also pricing in the economic slowdown that will result. Once we are past this rate spike and associated volatility, MBA expects that potential homebuyers may be more willing to re-enter the market. Given how much higher rates will remain above the past two years, we do not expect refinance demand to increase any time soon.”
The economist noted the moves announced on Wednesday were of little surprise as they had been hinted at in previous speeches by Federal Reserve Chair Jerome Powell: “There were two items to watch from the FOMC following this month’s two-day meeting,” Fratantoni noted. “First, they announced a 50-basis-point increase in the federal funds target. This change had been telegraphed clearly in recent speeches. The statement also repeated the language that the committee ‘anticipates that ongoing increases in the target range will be appropriate.’ In other words, we are far from done at this point. MBA forecasts that the fed funds target will reach 2.5%, the neutral rate, by the end of 2022.”