Mortgage Rates: Fed’s Status-Quo Decision Could Work to Borrowers’ Advantage

The benchmark 30-year mortgage rate has climbed 1.15% since May of this year, and that had a lot of would-be borrowers concerned. Home buyers, in particular, were disturbed by the rise in rates because it came at a time when home prices were also rising. Homeowners planning to refinance their homes watched helplessly as the “break-even” window got smaller and smaller.

But recent actions (or inaction) by the Federal Reserve may inspire a collective sigh of relief.

Fed Stimulus Continues for Now

It seems the Fed is not yet prepared to scale back its unprecedented stimulus program. This means they will continue to purchase billions of dollars worth of bonds and other securities every month. They also plan to hold short-term interest rates near zero for the foreseeable future. Citing less-than-ideal economic data, Fed officials said they will maintain the status quo for now.

Based on previous statements by key Fed officials, many analysts and economists expected the opposite last week. They were expecting the Fed to announce it was finally ready to begin tapering the massive bond-buying program, due to slow but steady improvements in the economy.

As it turns out, the U.S. unemployment rate is nowhere near what the Fed sees as “normal.” They have long cited the unemployment rate as a key factor in their decision making, and it is still higher than what they would like to see. The official statement following last week’s meeting of the Federal Open Marketing Committee (FOMC) said as much:

“Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated.”

Translation: No tapering just yet. Please stand by.

Fed officials have also said they want to see a sustained recovery, and not just a blip on the radar, before they begin scaling back on the stimulus measures. So the FOMC has decided to wait for “more evidence that progress will be sustained before adjusting the pace of its purchases.”

Of course, not everyone agrees with the Fed’s decision. Larry Fink, CEO of the investment management firm BlackRock, worries about the long-term effects of such a long-running stimulus program. “I think that’s going to create more of a bubble issue in the future and it’s going to make it more difficult to unravel this,” he said.

This latest decision could be good for home buyers and homeowners who are in the market for a mortgage loan. The continuation of the QE3 bond-buying program should keep downward pressure on mortgage rates. Sure, rates have risen over the last few months. But they likely would have risen a lot more had it not been for the actions of the central bank.

Freddie Mac economist sees 5% mortgage rates in 2014

Are Rising Mortgage Rates a Good Sign?

In response to the latest Fed announcement, housing analysts are now looking ahead with an eye on home prices and mortgage rates. Many were concerned that the combination of rising interest rates and home prices would put a damper on the still-fragile recovery in the housing sector. We have seen signs of this already, in the form of reduced mortgage-application volume.

But, as Trulia’s chief economist Jed Kolko points out, rising mortgage rates could be a positive sign in a macroeconomic sense:

“Here’s the missing piece of the puzzle: over the past decade and a half, mortgage rates have been higher when the economy was doing better. Since 1999, the correlation between the monthly unemployment rate – a good, if imperfect, measure of how the economy is doing overall – and the 30-year fixed rate was -0.8, making it a very strong relationship.”

The nation’s unemployment rate fell from 10% in 2009 to 7.3% in August 2013, as of the last reading. Still high, but clearly an improvement.

Mortgage lenders lower standards to maintain volume

How and When to Taper QE3

So, when will the Fed taper its QE3 stimulus program, and how will that affect mortgage rates in the U.S.? James Bullard of the St. Louis Federal Reserve Bank said the FOMC might be “comfortable with a small taper in October” if they see stronger economic data before their next meeting on October 29 – 30.

The one thing most people agree on at this point is that mortgage rates will likely rise further, if and when Fed officials begin to scale back their bond-buying stimulus program.

A lot will depend on how the Federal Reserve reduces its purchases. Currently, they are buying $40 billion worth of mortgage-backed securities (MBS) and $45 billion worth of long-term Treasury securities every month. Given the rise in mortgage rates of recent weeks, most analysts believe the Fed’s “stage-one” tapering will consist of a reduction in Treasury purchases, while continuing MBS purchases at the same level for a time.

But we’re wandering into the speculative weeds here.