The Federal Reserve

FEderal REserve StructureFebruary 2, 2015:  When the Federal Reserve met last week the governing body did not rock the boat and kept with previous statements and posture.  They left rates unchanged, however the statement was tweaked in a way to allow them to start rate hikes (normalizing monetary policy) later this year.  They said that economic activity was expanding at a “solid pace” with strong job gains.

Words are powerful:  One tool the Fed has is “forward guidance.”  This is “wording” that tells markets what to expect in the future.  Mrs. Yellen has said that the Fed can be “patient” in raising rates and indicated that “patience” means no changes for at least two more meetings.   By including it Wednesday the Fed took rate hikes off the table at their March and April meetings leaving the June 16-17 meeting in question.

Not all Fed meetings are created equal.  The governing body meets every six weeks, however they do not always include a press conference and updated economic projections from the members.  The meeting this week was one without a press conference or projections, leaving Mrs. Yellen without a soapbox to explain any changes in stance.  This was one reason few expected much change from the statement.  However the March 17-18 meeting brings updated projections and a press conference.  Mrs. Yellen will not remove the “patience” wording without an opportunity to explain her position.  Global market participants will be on edge as the meeting approaches.

Data Dependant:  As Mrs. Yellen has said repeatedly, any changes to Fed policy will depend on the economy.  If inflation remains well below their 2% target or the economy stumbles the Fed will delay rate hikes.  One metric they are laser focused on is jobs.  As the economy moves to “full employment” (the condition in which virtually all who are able and willing to work are employed) with an unemployment rate of 5.2%-5.5% any sign of wage inflation will pressure them to increase rates.

Global economy:  The US is the shining light for economic activity around the world.  As central banks of other countries continue to add accommodations, the Fed is poised to move to hike rates.  We are seeing bond buying (quantitative easing), rate cuts, and other activities to combat deflation and rising currency values from Europe to Canada to Asia.  It is rare to see so much disjunction between central banks.

What about rates:  Despite the fact the Fed is jawboning higher rates, yields in the US are falling.  One reason is the Treasury rates in the US are much higher than yields available from other strong countries such as Germany.  In Germany the 10-year Bund yields 35bps (1/3 of 1%) and the 30-year bund is less than 1%.   Rates in Germany are expect to fall further as the European Central Bank kicks off their own QE.  That makes a mortgage backed security yielding 3% or a 10-year Treasury bond yielding 1.75% a deal.

What to expect:  In a word, volatility.  There is no reason to believe mortgage rates will rise substantially in 2015 and they could fall as we have seen recently.  Keep an eye on the economic data calendar and prepare yourself and your borrowers for the possibility of rapid rate movements.  Not all volatility is bad, however all volatility is disruptive.


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