The June Federal Open Market Committee (FOMC) meeting is June 13-14 2017 and investors have already priced in the likelihood of an interest rate hike.
According to the CME FedWatch Tool, the probability of an FOMC rate move from 0.75 – 1.00% to 1.00 – 1.25% is well above 95%.–. If the Federal Reserve (aka the Fed) raises rates, it’s unlikely that we’ll see a tremendous impact on mortgage interest rates. If they don’t, however, the market could react, and we could see lower rates.
For those of you looking to buy a new home or refinance your existing mortgage, you may be curious why and how Fed rate hikes affect mortgage rates. To understand this, let’s first visit what monetary and fiscal policy are.
What is Monetary Policy?
The Fed is mandated to stabilize prices and maximize employment. In other words, to manage inflation and jobs. Typically, it implements monetary policy by setting the target fed funds rate. But the effectiveness of this tool is limited by the zero lower bound of interest rate. At negative interest rates, you get paid to borrow!
After the previous financial crisis, the Fed cut the fed funds rate to lower bound of 0 – 0.25% and employed unconventional monetary policy options, namely quantitative easing. Since then, it has bought a lot of Mortgage-Backed Securities (MBS) and US Treasury Bonds for its System Open Market Account (SOMA). Over the past eight years, its total holdings (in black) and MBS holdings (in gray) have grown while 30yr fixed mortgage rates have trended lower.
Quantitative easing in the form of asset purchases has put downward pressure on mortgage interest rates and supported housing prices. With sustainable economic growth underway, investors are paying more attention to the size of the Fed’s balance sheet, which some economists believe the Fed will start shrinking in the next 12 months. If they do, it’s likely that mortgage interest rates will stay low for longer as the Fed is the largest holder of MBS.
What is Fiscal Policy?
The government can also influence the economy by increasing or reducing its budget deficits. Higher spending and lower taxes accelerate economic growth while the opposite slows it down. Established in 2008, The Troubled Asset Relief Program (TARP), also known as the bailout package, was a textbook example of a fiscal policy aimed to stimulate the economy. Our CEO, Jeff Foster, served as a member of the Financial Crisis Response Team, designing and implementing programs to deploy TARP funds optimally.
Particularly related to the mortgage world are the Home Affordable Refinance Program (HARP) and Home Affordable Modification Program (HAMP). Some of you may have refinanced through HARP designed to allow borrowers with LTVs over 80% to qualify and take advantage of lower mortgage rates or modified your prior mortgages through HAMP to increase their long-term affordability and sustainability.
Fiscal policy is not instituted only at the federal level. State and municipal governments can carry out their own fiscal policies statewide and regionally. For instance, Housing Finance Agencies (HFAs) are chartered at the state level for meeting affordable housing needs. If you live in California, you may be eligible to apply for the CalFHA down payment assistance program.
What Do They Have to Do with My Mortgage Rate?
Both the government and the Fed play an integral role in maintaining a healthy housing finance system. However, because mortgage rates in the US are set by the market rather than the government or the Fed, the complete picture is a bit more complicated.
If the Fed tightens monetary policy due to a robust labor market, stable financial conditions, and a not yet overheated economy, it sends a positive message on the economy, and all of us benefit. Although HAMP is already expired and HARP has been extended through only September 2017, most parts of the country have experienced steady home price appreciation. As a result, average Loan-to-Value ratios (LTVs) are down from post-crisis highs, and refinancing opportunities are opening up to more borrowers. Simply put, we do not expect to see a sharp spike in mortgage rates back to historical norms (6.75% pre-2008) since that would be disruptive to the housing market and the economy. At the same time, continuing strong economic growth does warrant higher interest rates, which prevent the housing market and the economy from overheating and getting out of control like the last time.
If you’re looking to buy or refinancing, now is a good time from the perspective of mortgage interest rates. It’s unlikely that they will get much lower and they could rise over time.