FOMC Announces a 0.500% Fed Funds Rate Hike

May 04, 2022

In the just-released FOMC statement, the Fed announced a 0.50% hike in the Fed Funds rate. They also announced the beginning of the runoff of their Treasury and MBS bond portfolios that were built up as a quantitative easing response to the pandemic. The runoff announcement follows the description that appeared in the meeting minutes of the March 16 FOMC meeting, no surprises there. That makes today’s moves as expected and, by and large, have already been priced into term bond markets.

The tone and additional guidance in the announcement and in Chair Powell’s press conference that follows will help the market understand what the Fed’s plans are for the inflation-fighting campaign going forward. That guidance has a difficult course to navigate with the record level of inflation, the likes of which has not been seen since the 1980s. With the policy statement out and as expected, we shouldn’t relax just yet. The forward guidance could still deliver a surprise to the bond markets today.

Any new guidance today will help markets to understand how the Fed is looking at the many cross-currents that could impact the economic expansion in the intermediate term. To name a few, there’s slowing growth from the retired federal assistance pandemic response, the impact inflation is having on consumption, increasing labor force participation and wage pressure, global economic and geopolitical factors, not to mention the lingering possibility of a new COVID-19 infection wave. A lot of moving targets for market expectations to consider on any given day.

What’s Next?

That said, getting today’s formal announcements and fresh guidance was a prerequisite to the MBS TBA market regaining the more ordinary premium levels that have been absent since March. And that’s required to relieve originators from pricing with unusually high levels of discount points and navigating points & fees and APOR compliance violations that are difficult for borrowers to understand and appreciate.

Of course, there’s no certain way to predict how quickly premium levels will return, but an MBS TBA market not subject to a constant push by the primary market into higher coupons that have yet to see new production deliveries is a good start.

What Do Borrowers Do Now?

In these uncertain times, bond market volatility is at a high level. The most followed bond volatility measure is the MOVE index, which is at 126.46 as I write this. The normal range for the MOVE index is 80 to 125. This high level presents as much of a challenge to lenders and borrowers as the increase in rates does. Volatility refers to the amount prices (or yields, rates) are expected to rise and fall over a short period of time, typically 30 days. This level of risk is priced into option markets and makes forward settlement rates more expensive.

From one day to the next, this heightened level of volatility makes waiting to rate lock a greater risk. Therefore it’s prudent to rate lock mortgage financing as soon as possible and avoid the cost of the chance of (even) higher rates in the intermediate term.

Originators should explain to borrowers who want to finance the purchase of a home that the current mortgage rate market is more expensive because of the higher level of uncertainty in the bond markets – due to the Fed’s evolving monetary policy struggle to contain inflation. And that factor alone can make waiting to rate lock a greater risk that rates will be higher over the next 30 days.

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