In the just-released FOMC statement, the Fed confirmed tapering of their bond purchase program will be done by March and we should expect the first of four 0.25% Fed Funds rate hikes in 2022 to commence. This clarifies the recent Fed Governor’s public comments and reassures the analysts and investors that they understand where the Fed stands at this moment.
This also means we understand the Fed’s interpretation of the recent slower economic signals attributable to the impact of the Omicron variant, and the level of concern the Fed is placing on the domestic equity market correction.
But that’s today. It doesn’t mean that equity market volatility or the bear flattening yield curve won’t continue (short term bond yields moving up faster than longer term bond yields are moving up). The forces driving those actions will continue to evolve and market investors will continue to adjust their Fed expectations from today going forward. Fresh economic data and the ever-changing COVID situation will quickly (re-)build investors’ uncertainty to where it was immediately before today’s policy statement.
One significant unknown that the December FOMC meeting minutes put into play is how the Fed will bring down the size of their bond portfolio once the tapering is complete. The minutes revealed the FOMC discussed plans to allow the portfolio to rolloff.
Tapering is about the Fed slowing the growth of its bond portfolio. The next step, referred to as “rolloff,” is about how fast they allow the portfolio to shrink. Expect to hear about rolloff plans during Powell’s press conference which will begin 30 minutes after the 1:00 p.m. Central time policy statement was released.
Rolloff refers to the Fed re-investing less than all of the cash the portfolio is generating from coupon payments and bond maturities (monthly P&I payments and prepayments from the MBS portfolio). The overall size of the portfolio will run down faster the less the Fed reinvests. The faster rolloff is allowed to happen, the more it will act as an additional form of tightening monetary policy. Since the Fed can control rolloff, they can decide how fast it will play out at the same time they decide on Fed Fund rate increases.
If tapering is the Fed taking its foot off the gas pedal, and Fed Funds rate hikes are putting a foot on the brake pedal, allowing rolloff at the same time is equivalent to putting both feet on the brakes simultaneously. That makes their guidance on rolloff just as important for the markets to understand as guidance on rate hikes.
And there is an even more extreme step they could take. Beyond rolloff, the Fed could begin to sell bonds from its portfolio to reduce its size faster. That possibility shouldn’t happen without a clear and early warning.
What Do Borrowers Do Now?
I’ll keep beating this drum. 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 (even) 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 level of uncertainty in the bond markets due to the Fed’s evolving monetary policy struggle to contain inflation even while the pandemic continues and flight to safety bids may occur from geopolitical situations like what’s going on in the Ukraine with Russian troops massing on the border there.