In the just-released FOMC statement, the Fed announced the tapering of their bond purchase program. They also announced no change to the Fed Funds target rate, leaving it in the range of 0.00% to 0.25%. Both announcements were expected.
The “new” news in this announcement is the tapering details: how quickly the taper will happen and if MBS monthly P&I payments will be reinvested, or not. The latter possibility indicates a more aggressive tapering than previous tapering efforts.
These details matter because market investors see them as signals of the Fed’s most current inflation expectations. There could be a reassessment of these signals if the market interprets that the Fed’s current “inflation is transitory” guidance is not being adjusted to keep up with the latest inflation data.
The least disruptive outcome today will be the market seeing the Fed as adjusting its transitory inflation outlook to account for inflation spreading to areas of the economy not directly impacted by pandemic related supply chain problems. In other words, inflation is becoming less transitory and more problematic.
A possible reassessment of the Fed’s inflation outlook could go either way. The Fed could be interpreted as seeing inflation being (even) less transitory, and rate hikes will follow earlier than projected. Or, that the Fed is not adjusting its transitory assessment enough, leading the market to react to protect itself.
The cautionary thing is, either of those outcomes would drive longer term yields higher. That would push mortgage rates up. And if that rate movement is severe enough, it could lead to even more MBS selling (even lower prices, pushing even higher rates). That could happen if prepayment expectations cross the inflection points where refinance activity would seriously plummet. That would drive MBS duration measures to extend longer and MBS investors to sell more MBS to counterbalance that effect. That’s a lot to take in, but the current market environment makes this a possibility that we should be aware of.
What’s Next?
With tapering formally announced and underway, the market’s attention will fully focus on when the first rate hike will occur and the forecast for additional rate hikes over the intermediate term while the pandemic and economic recovery play out. That will make increase the possibility for higher market price volatility. And that makes speculation a potentially deal killer for any borrower not locking in a rate they qualify for.
That could happen to borrowers unaware of the current situation. With rates elevated since this summer, some borrowers may be hoping for a return to those recent historic low levels. But as they say, hope is not a strategy.
What Do Borrowers Do Now?
All things considered, mortgage rates are still low. It is prudent to rate lock a mortgage loan as soon as possible and avoid the chances of higher rates in the intermediate term.
Borrowers who want to finance the purchase of a home or homeowners who want to refinance their existing mortgage loan should appreciate that the current mortgage rate market has more volatility because of the higher uncertainties in the bond markets.
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