Will Mortgage Rates Really Soar When the Fed Exits the Market?

by Alex Stenback on February 2, 2010

Almost everybody (this writer included) expects mortgage rates to rise once the Fed concludes their $1.25 trillion mortgage shopping spree on March 31st.

Estimates vary, but most expect rates to move up by .25% – .75%.  After all, the whole point of the program was to force rates lower, right?  So it only stands to reason that rates will rise once this “artificial” (the Fed has no real reason to own mortgage debt otherwise) demand goes away.

At least this is the conventional wisdom.

But then there is this more optimistic take (from the Wall Street Journal) which surmises that rates may just stay low without the Fed’s direct intervention:

The optimistic view hinges on the government remaining an enormous presence in the mortgage market, both through its mortgage-backed securities holdings and the widespread expectation that it could jump back in if the market falters.

If this view is right, then the end of Fed purchases will barely cause a ripple in interest rates on mortgage-backed securities, which move in the opposite direction of price. That, by extension, could mean mortgage rates could stay relatively low, buoying housing.

So far, the numbers support the optimists. In recent weeks, the Fed has slowed its average weekly net purchases of mortgage-backed securities from $21 billion to about $12 billion. Despite this slower purchase rate, the “spread” between mortgage-backed securities yields and risk-free Treasury yields is thinner than last September, when the Fed said it was extending its mortgage buying program by a quarter.

I’d also add that, from a fundamental standpoint, the economy (including the labor markets) will probably need to be clearly improving before we see to much in the way of sustained higher mortgage rates.
Mortgage Bulls Bid Fed Adieu [Link]
Mark Gongloff, Wall Street Journal, Jan 28th 2010
· http://online.wsj.com/article/SB10001424052748703410004575029610236173870.html?

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