The mortgage industry is known for the use of acronyms and even acronyms within acronyms (TRID, anyone?). However, there is an acronym that is highly relevant to the current interest rate environment: ZIRP, which stands for “Zero Interest Rate Policy”. As can be seen from its definition, this term describes the current policy of the Federal Reserve to keep the Fed policy rate near 0% for the foreseeable future due to the economic challenges of the COVID-19 pandemic.
For some, it may be easy to assume that Fed funds will lock up interest rates, which means mortgage rates will remain at the historically extremely low levels the industry has seen during the pandemic. Not only does history tell us it is not, but the recent rise in interest rates due to the surge in government bond yields and increased economic spending provides even more timely evidence that interest rate fluctuations are possible, if not inevitable, during ZIRP. Therefore, in spite of the current ZIRP, lenders and executives in the capital markets must be prepared for interest rate fluctuations in both directions.
The last time the Fed introduced ZIRP followed the global financial crisis, which lasted seven years from December 2008 to December 2015. In December 2008 the average key rate on 30 year mortgages was 5.14%, when ZIRP ended in December 2015 the face value was 3.31%. That long span of seven years, however, was not a gentle freeway ramp. Despite the Fed's ongoing pledge to "stay lower for longer," there have been both bull and bear markets for mortgage rates. Despite a Federal Open Markets Committee (FOMC) target for short-term interest rates of 0.00% to 0.25%, mortgage rates have seen several sharp swings.
During the so-called tantrum (remember listening to that conversation earlier this month?), The market feared the Fed would reduce its purchases of government bonds and mortgage-backed securities, causing mortgage rates to rise over 100 basis points in 3 short months . Over a further period of just 9 weeks, the prices of the lowest coupon mortgage-backed securities fell a whopping 800 basis points from 101 to 93. All of this activity took place over two years before the Fed actually introduced the slightest push in its Fed rate policy .
Given the current environment, the Fed has announced that it will not raise the Fed's key rate until at least 2023. However, as the industry has already established, that doesn't mean that mortgage rates will be in the same range as they are. “I've been with it for 10 months. In fact, it wouldn't be uncommon for even a whole percentage point to change up or down no matter how long that current ZIRP has been around. In fact, in anticipation of this inevitability, both Fannie Mae and Freddie Mac have forecast modest rate hikes in 2021, although rates could certainly go in the opposite direction given the right market conditions.
For the past few months I've heard people say, “The market has not gone anywhere for a few years. The Fed said it and it's already priced in, isn't it?” While that may be the case with excess reserve interest and Fed funds That the Fed has pegged near zero, there will be no alarm letting lenders know they need to lock their doors. Just because the Fed stays in the loop doesn't mean that mortgage rates and MBS rates will stay in the loop too. As history has shown, shocks can and do occur when markets least expect them.