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Interest Rates in the Post Fed-Purchase World

Many experts believe that 30 year mortgage rates will rise quickly and dramatically once the Fed ends their policy of purchasing mortgage-backed-securities at the end of this month. However, as we get closer to the Fed’s exit there seems to be debate as to how much of an impact it will have.

On one side of the debate are industry players like Guy Cecala, publisher of Inside Mortgage Finance, who said in an article in the San Francisco Chronicle:

“There is no question rates have been kept artificially low by the Fed’s heavy buying. My opinion is that rates will go up a full percentage point initially, meaning that 30-year fixed conforming loans, now hovering around 5 percent, would hit 6 percent.”

This group is basing their projections on the fact that the Fed had originated a huge percentage of the mortgages over the last two years as evidenced by the graph below:

They feel there is not the same appetite for mortgages in the private sector especially at the 5% mortgage rate.

Yet others feel that the impact of the Fed’s exiting will be less dramatic. As an example, the Wall Street Journal in an article last week reported:

“Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP in New York, estimates that the Fed move will add a maximum of about 0.25 percentage point to mortgage rates. “There is a lot of private money on the sidelines,” waiting to buy mortgage securities once the Fed stops gobbling most of them up, Ms. Goodman says. She points to banks, money managers and foreign investors.”

In that same article, this graph was included showing that:

“…analysts at Credit Suisse and FTN Financial Capital Markets forecast that mortgage rates will be in a range of roughly 5% to 5.25% at the end of 2010. Moody’s Economy.com projects about 5.7%, and Barclays Capital 6%.”

Also HSH Associates in their Two Month Forecast on March 8 stated:

“Although we don’t usually provide an outlook for conforming 30-year fixed rates by themselves, we’ll wing it a little this time, and call for a 5% to 5.40% range over the next couple of months.”

Those who doubt there will be a dramatic increase feel that the Fed will not sell the inventory of mortgages they currently have anytime in the near future thus limiting the supply available to the private sector. That is probably correct.

However, others feel that even if that is the case there will be drastic increases in the 30 year rate.

Christopher Thornberg, principal at Beacon Economics in the same SF Chronicle article mentioned above said:

“Clearly, when they stop printing all that money, it’s going to be a shock to the system. I have to assume that when they pull back on it, it will cause a 100- to 200-basis-points rise to rates of 6 percent or 7 percent. When they start selling off the stuff they purchased, which by my guess would come early next year, which would cause another 100- to 150-basis-points rise.”

What does this mean to you?

I still strongly believe rates will climb rather quickly upon the Fed’s exist; however, the best quote I found on the point was from Gillian Tett in the Financial Times:

“For the moment, at least, the only honest answer is that nobody truly knows. The global financial machine has been so distorted by government aid that it is frustratingly hard for anyone to be entirely sure how the cogs are working. So, right now, there is reason for American officials to feel some relief about what is happening in the mortgage world; the calm is profoundly good news. But although I very much hope it lasts, I would not be willing to bet too much money on that. I fear this may yet be a lull before a bigger storm.”

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2 replies
  1. Debbie Kirkland
    Debbie Kirkland says:

    Thank you for the outlook that most of us following this market also feel is on the track that you predict. The rumors of FHA raising down-payment requirements to 5% are even more problematic. We have not seen the end of economic distress and the learning curve continues.


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