Mortgage

A brand new Fed coverage may imply years of low mortgage charges

Fed policy to keep mortgage rates low

On August 25, US Federal Reserve Chairman Jerome H. Powell delivered an important speech that should be good news for borrowers and mortgage rates.

He announced a major change in policy that will almost certainly keep interest rates – including mortgage rates – low for years to come.

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In short, new Fed policies mean interest rates remain low

The Federal Reserve's new guidelines are detailed below. But here is the short version:

In fact, the Fed has signaled that it is far from tightening monetary policy as the post-COVID economic recovery will be so uncertain.

Hence, interest rates are likely to remain low for years.

And that should also apply to mortgage interest.

As the New York Times put it in a recent article, "This could result in long periods of cheap mortgages and business loans that encourage strong demand and a solid labor market."

This does not mean that rates will go down. Current home buyers and refinancers shouldn't be too affected.

But those looking to buy or refinance a home in the months and years to come should have low interest rates to look forward to.

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What the Federal Reserve (usually) does

The Fed has long had two main political goals:

To keep the inflation rate at an average of 2% per year. To keep employment high and unemployment low

And you can see that it did a pretty good job in general. The following graphs for the 21st century were obtained from FRED, the Federal Reserve Bank of St. Louis:

United States Labor Statistics, Unemployment Rate (UNRATE), retrieved from FRED, Federal Reserve Bank of St. LouisInflation also plays an important role in determining mortgage ratesWorld Bank, Inflation, Consumer Prices for the United States, retrieved from FRED, Federal Reserve Bank of St. Louis

Yes, there have been some peaks and valleys, especially in response to recessions (the periods shaded gray). But nothing has gotten out of hand. Until 2020.

Now look at the unprecedented rise in unemployment on the far right of the graph above. At the beginning of this year it rose to 14.7%.

Yes, unemployment is falling. However, the unemployment rate was still 10.2% in July 2020, which is more than 16 million people out of work.

And we are far from guaranteed recovery from COVID – or even a guarantee that the pandemic is about to end.

With so much change in the economy and so much uncertainty about how long it will last, the Federal Reserve had to tweak its policies to meet those pillars of 2% inflation and high employment.

How Federal Reserve Policies Changed in Response to COVID

Obviously, special measures were needed to tackle unemployment.

Powell and his colleagues on the Fed's highest political committee (Federal Open Market Committee or FOMC) have therefore developed a new approach, which is set out in their new “Declaration on Longer-Term Goals and Monetary Policy Strategy”.

This essentially involved a realignment of the Fed's priorities.

Inflation policy

Rather than seeing employment and inflation as equally important, this would help boost job creation for the time being, even if it means inflation getting a little freer.

In his speech Powell said:

“To achieve inflation that averages 2 percent over time, we don't tie ourselves to any particular mathematical formula that defines the average. Hence, our approach could be seen as a flexible form of the average inflation target. "

Employment policy

And the Fed made a second change. Powell continued, "The committee has not set a numerical target for maximum employment."

In this way, the Federal Reserve can continue to support employment growth even when employment levels are high (and vice versa, unemployment is low).

In other words, the stimulus policy is expected to be implemented for a long time to come.

As Powell put it, "Employment can safely reach or exceed estimates of its peak levels in real-time, unless accompanied by signs of an undesirable spike in inflation."

Effects on Interest Rates

To the average ear, the Fed's new policy might sound too nuanced to have much of an impact.

As former Federal Reserve Chair Janet Yellen said on Aug. 27:

“It seems like a pretty subtle shift from most normal people. Most of the Fed's history, however, has been about keeping inflation under control. "

New guidelines mean the Federal Reserve's policy rate could stay the same or go down even if the economy begins to improve.

"This really reflects the crucial realization that we are in a completely different environment," says Yellen.

Markets and investors quickly realized the importance of Powell's statement. They saw it as a very significant change.

This is because the Fed Funds Rate (the target rate) is likely to stay the same (close to zero) even if inflation rises above the 2% mark or if the job market is hot.

But the Fed doesn't set mortgage rates, does it?

Every time the Federal Reserve announces a change in their interest rates, loan officers and mortgage brokers are bombarded with calls from borrowers asking what this means for their mortgage rates.

The standard answer is, “Nothing. The Fed doesn't set mortgage rates. "

And you are quite right. Changes in the Fed Funds policy rate will have a direct impact on a wide variety of credit products, but not on mortgages (with the exception of existing adjustable rate mortgages (ARMs)).

How are mortgage rates determined?

Mortgage rates are determined by supply and demand in a "secondary market" where mortgage-backed securities (bundles of mortgage rates) are traded. And usually the Fed has no say in this market.

The Fed has had a bigger hold on mortgage rates lately as it has bought mortgage-backed securities itself. However, this is a temporary intervention and a diversion from normal principles.

Changes in Federal Reserve policy, however, affect the general sentiment of the market. And that can have an indirect impact on mortgage rates.

What the Fed's change means for mortgage rates

Within a few days of Powell's speech, at least one lender was promoting, "Fed stimulus slashes mortgage rates – Fed stimulus slashes mortgage rates to insane lows."

It is not clear whether this was directly related to the last announcement or to previous actions by the organization.

However, it does reflect the general feeling that the latest news from the Fed is good for mortgage and refinance rates.

Those in the process of buying or refinancing shouldn't wait to lock an interest rate. Mortgage rates are already near record lows and are unlikely to fall any further.

However, this does not mean that those in the process of buying or refinancing should wait for interest rates to fall before locking in.

Average mortgage rates have only fallen a few inches since Powell's speech. And they are already near record lows. As a result, borrowers shouldn't expect drastically lower interest rates thanks to the Fed's actions.

Rather, Powell's announcement should be viewed as good news for those looking to buy or refinance in the future, as interest rates are likely to remain at or near their current levels for some time.

Long-term hazards

And there are those who fear the long-term consequences for mortgage rates.

Industry guru Matthew Graham writes for Mortgage News Daily and warns of the dangers of the Fed leaving the inflation ball out of sight: “High inflation is bad for low interest rates. This also means a higher comparative level of economic activity and employment. These things aren't good for prices either. "

And he's right. The last thing investors want is to get stuck in a time of high inflation with a plethora of fixed income, low-yielding, mortgage-backed securities. You inevitably lose money.

Lower mortgage rates are still the likely outcome

Right now, however, these investors have much more to worry about than possible future inflation. And few expect inflation or employment to hit worrying levels for years.

It is therefore likely that the consensus view that Powell's speech will be good for mortgage rates will hold true for now. Let's hope the time is several years.

Your next steps

If you're already buying or refinancing, the Fed's latest announcement shouldn't bother you too much.

Interest rates are already very low and, according to Powell, shouldn't go down. So there is no real reason to wait for it to be locked.

But if you are planning on buying a home or looking to refinance anywhere down the line, cheer yourself up. It seems like current prices aren't going away anytime soon.

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