Everyone gets that one very big reason mortgage rates are so low is because the Federal Reserve has been pumping billons of dollars into the bond market, right?
Here’s how it works: The Fed buys bonds. Lots and lots and lots of them. This buying drives bond prices higher (supply and demand 101) which in turn drives yields, or rates, lower.
This has been called “Quantitative Easing” or QE, but all it really means is the Fed is using the power of the public purse to force rates lower than they otherwise would be. It’s like the Fed is stretching a rubber band towards the floor.
The result? Lowest rates almost-ever.
Anyway, this is important to understand because eventually, it will come to an end; and smart observers are wondering what exactly will happen when the Fed lets go of the rubber band.
In fact, Bill Gross, the worlds most watched and most influential bond investor (founder of PIMCO) sees this as the financial markets modern day equivalent to D-day:
“…view June 30th, 2011 not as political historians view November 11th, 1918 (Armistice Day – a day of reconciliation and healing) but more like June 6th, 1944 (D-Day – a day fraught with hope for victory, but fueled with immediate uncertainty and fear as to what would happen in the short term). Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets.”
In other words, the (literal) hundred billion dollar question is: Who will buy bonds when the Fed stops, and will there be enough buyers to keep rates, including mortgage rates, low when the Fed turns off the money-faucet. Will rates rocket higher and choke-off the recovery? Will private markets step in to take up the slack?
Nobody really knows, but Bill Gross is not optimistic - the risks are too high:
“PIMCO’s not sticking around to see the [markets] reaction.”
Bottom line: If you are an aspiring homeowner, are you willing to bet the payment on your home for the next 30 years on the outcome?
Two Bits, Four Bits, Six Bits, a Dollar [PIMCO]
[ 3/3/11 Update: Edited and added to this to clarify]