Some talking points from our friends at RateLink – www.ratelink.com
Interest rates rose ¾% this week despite the fact the Fed continues to purchase mortgage bonds and has not changed their current outlook. What has changed is investors’ perception on future actions from the Federal Reserve. At the Fed meeting Wednesday Chairman Bernanke gave the world a basic lesson in economics, which every trader already knew and only exacerbated investor fears.
The Federal has a dual mandate of price stability (read inflation) and full employment. At the onset of the financial crisis the Federal Reserve took extraordinary steps to support the banks and the economy. Following the collapse of Lehman Brothers in 2008 the global banking and financial systems came to the brink of collapse. Central banks around the world raced to avoid a total meltdown, which could destroy most of the wealth in the world. When standard policy tools failed to stop the bleeding they began to take extraordinary steps. The Fed Funds rate, a “standard” policy tool has been at zero for years and will remain there for years to come. Quantitative easing (QE), the practice of buying MBS’s and Treasury bonds is an “unconventional” tool used to push rates below the levels that “conventional” tools will allow. The Fed has purchased in excess of $3T ($3,000,000,000,000) in bonds pushing interest rates to historic lows. As economists have cited since the beginning of the unconventional policies, it is the unwinding that is hard. Driving into a ditch is easy, it’s getting out that is difficult.
Basic economics teaches that the Fed will reduce accommodations as the economic picture improves. At the Fed Meeting this week, Chairman Bernanke told the world that IF the data continued to improve the Fed COULD begin tapering asset purchases later in 2013 and be finished by the summer of 2014. Market participants ignored the IF and COULD and focused on the dates Bernanke spoke of. You know the rest.
• Keep a lock bias until the market settles down.
• Economic data takes on much bigger importance.
• You did not cause this and you can fix it. Don’t take the blame
• The rate spike only effects your current pipeline, the hostile and ugly calls will diminish quickly.
• Each Thursday weekly jobless claims are released.
• July 5th. Due to the July 4th Holiday on Thursday both weekly claims and the monthly jobs report will be released.
• July 10th, minutes from last Fed meeting will be released. It will be interesting to see who said what. This is a mid-day release, be extra careful
• July 17th and 18th, Bernanke appears on Capital Hill to testify to Congress
• July 31st, next Fed meeting
A basic rule of interest rates is the rise like a rocket and fall like a feather. Expect the volatility seen recently to continue but at lower levels. Remember, some volatility is good. Economic data will become even more important. Data that is better than expected will fuel the belief that the calendar dates Bernanke spoke of will come to fruition and traders may run for the door driving prices lower and rates higher.
Economic Data: We know the Fed is watching the unemployment rate and has tied Fed actions to it. The Fed expects QE to be finished when the unemployment rate hits 7%. At 6.5% the governing body will begin to increase the Fed Funds rate. Most expect the Fed Funds rate to remain at or near the current level of –0- until at least late 2015.
Fear and Greed: Of the two emotions Fear is stronger and can cause panic trading like we are seeing now. Who wants to hold a 10-year Treasury note paying 1.65% (a few weeks ago) when the exact same bond pays 2.48% (today)? Once prices get running down they are hard to stop, it’s hard to put out a fire. That said, once the smoke clears we could see rates recover somewhat.
Economic Outlook: The Federal Reserve believes the US economy will recover faster than many global economists. Their projections for GDP growth and unemployment are rosier than many professional trading houses. For several years the Fed has projected much better growth than what was achieved forcing them to reduce future assumptions. If the economy stumbles the Fed could and probably would increase asset purchases.
Watching the Fed: Bernanke will taper off purchases not stop them immediately. The Fed purchases roughly $2-3B in MBS’s a day. That is a lot of buying support and is currently fixed at those levels as Bernanke assured the world on Wednesday. The recent rise in rates will slow the issuances of MBS’s, making the Fed an even bigger player. Think of it as insurance.
Yes, rates have risen from the levels where they were even a week ago. However, they still remain near historic lows. A buyer with a 30-year mortgage at 4.5% will be elated in the future when bank CD’s are paying 5% like they did a few years back. Housing affordability is high. A buyer can still purchase so much more house today than at almost any time in the recent past.