Mortgage rate set to exceed 4% in 2022 as Fed cut plan approaches

The Federal Reserve could start cutting back on mortgage-backed securities purchases as early as November, giving a boost to market forces that have pushed mortgage rates higher in recent weeks.

The Fed was careful to telegraph its intentions, in order to avoid surprising investors and sending rates soaring too quickly, as happened during the “temper tantrumOf 2013.

The minutes of the Federal Open Market Committee’s September meeting provide further details on the committee’s thinking and how quickly it could withdraw support for mortgages and government bonds.

At the start of the coronavirus pandemic, the Fed began increasing its holdings of mortgage-backed securities by $ 40 billion per month, and also added $ 80 billion per month to its long-term Treasury holdings.

These asset purchases helped drive mortgage rates to record highs as increased demand for mortgage-backed securities meant investors – the ultimate source of funding for most home loans – would accept lower yields.

By making borrowing cheaper, the Fed hoped to help avoid an economic crash during the pandemic. But with inflation now higher than some would like, most members of the Fed’s monetary policy committee believe it will soon be time to cut back on those purchases.

Fed September Minutes meeting show that if the economic recovery remains “largely on track”, committee members generally agree that “a phase-down process that was completed by the middle of next year would probably be appropriate “.

Assuming committee members agree it’s time to cut back after their next meeting ends on November 3, “the downsizing process could begin with monthly purchasing schedules starting in mid-November or mid-November. -December “, read the minutes.

At the September meeting, committee members also came close to agreeing on the mechanics of tapering. There has been speculation that the Fed may prioritize deeper cuts in mortgage-backed securities or treasury bills.

An “illustrative path” proposed by Fed staff members would reduce purchases proportionally over eight months, reducing purchases of mortgage-backed securities by $ 5 billion per month and treasury bills by $ 10 billion per month. month.

A scenario for the Fed’s tapering

A scenario that the Fed is considering to reduce its purchases of treasury bills and mortgage-backed securities. Source: Report of the meeting of the Federal Open Market Committee.

Should the Fed decide to start tapering in December, purchases to increase the Fed’s holdings of mortgage-backed securities and Treasuries would end in July, even if the Fed would continue to maintain its balance sheet by replacing maturing bonds.

While no final decision has been made on when or how fast to cut back, Fed staff said the scenario discussed at the September meeting was designed to be “easy to communicate,” and committee members generally agreed that it provided “a simple and appropriate model”. that they could follow.

“Giving the general public notice of a plan in this direction may reduce the risk of an adverse market reaction” to the reduction, noted two committee members.

Speaking during a event in south dakota this week, Fed board member Michelle Bowman expressed support for a phase-down ending in mid-2022.

Michelle bowman

“In my opinion, our asset purchases were an important part of our response to the economic effects of the pandemic, but they essentially served their purpose,” Bowman said. “I realize that the remaining benefits to the economy from our asset purchases are now likely outweighed by the potential costs.”

Bowman, appointed by Trump, said she was particularly concerned that the Fed’s asset purchases “may now be contributing to the pressures on valuations, particularly in the housing and equity markets, or that the Maintaining a very accommodative monetary policy at this stage of economic expansion could pose risks to the stability of long-term inflation expectations.

If the economy continues to grow as Bowman expects, “I will support a rate of reduction that ends our asset purchases by the middle of next year.”

But the minutes of the September meeting reveal that several members of the committee “preferred to proceed with a more rapid moderation of purchases”.

James bullard

This would include St. Louis Federal Reserve Chairman James Bullard, who told CNBC this week that he would like the reduction to start in November and end at the end of the first quarter of 2022.

Although Bullard has long been a proponent of “quantitative easing,” he says he now favors a quick cut so the Fed can start raising short-term rates to fight inflation, if necessary. .

Federal Reserve Chairman Jerome Powell has said that the Fed will not start raising the short-term federal funds rate – which it cut to 0% at the start of the pandemic – until it begins to hike. not finished decreasing.

“I just want to be able in case we need to move earlier than we can do next year in the spring or summer if we have to,” Bullard told CNBC.

The FMC FedWatch Tool, which monitors futures contracts to calculate the likelihood of a Fed rate hike, shows that markets are evaluating expectations of two 0.25 percentage point increases in the fed funds rate next year, with a 53% probability that the first increase will be approved in July 2022.

Mortgage rates, which are driven by market forces including investor appetite for mortgage-backed securities, have already risen amid concerns about inflation and the Fed’s cutback.

Mortgage rate forecasts

Historical (through Q2 2021) and projected (Q3 2021 and beyond) rates for 30-year fixed rate mortgages. Source: Association of Mortgage Bankers.

In a September 21 forecast, Mortgage Bankers Association economists have predicted that 30-year fixed-rate mortgage rates will rise 20 basis points per quarter next year, or an average of 4% in the last three months of 2022. MBA forecasters expect 30-year fixed-rate loans to average 4.3% in 2023.

Rising mortgage rates have already dampened demand for refinancing and could dampen increases in home prices – a development many homebuyers would welcome. But a sustained rise in mortgage rates could also hurt home sales, some experts have warned.

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