January 7th, 2010

Dissension in the Fed as They Walk Their 2010 Tightrope



We couldn’t agree more with John Canally, an economist at LPL Financial, when he said that the Fed is walking a pretty narrow tightrope in 2010.

The Fed’s decision to purchase Fannie and Freddie mortgage-backed securities (MBS) has been extremely successful at lowering conforming mortgage rates to 50-year lows, and driving potential buyers into the market.

But what makes the Fed’s tightrope especially narrow in 2010 is that the program is due to expire in the next few months — and there’s dissension in the Federal ranks over whether or not to extend it.

The minutes from the latest Federal Open Market Committee (FOMC) meeting stated that while “a few members” felt as though the Fed’s MBS purchase program should be extended, “one member” felt the opposite:

“A few members noted…that it might become desirable at some point in the future to provide more policy stimulus by expanding the planned scale of the Committee’s large-scale asset purchases and continuing them beyond the first quarter, especially if the outlook for economic growth were to weaken or if mortgage market functioning were to deteriorate.”

“One member thought that the improvement in financial market conditions and the economic outlook suggested that the quantity of planned asset purchases could be scaled back, and that it might become appropriate to begin reducing the Federal Reserve’s holdings of longer-term assets if the recovery gains strength over time.”

So where does this leave the Fed and their big decision?

“Growth will hinge in no small part on the skill of government officials,” writes Knight Kiplinger in the latest edition of The Kiplinger Letter. “If they pull back too quickly or too slowly, it could have a devastating effect, either snuffing out a nascent recovery or bringing on a dangerous round of inflation.”

Sounds like a narrow tightrope to us.

But what about mortgage rates? According to HSH.com’s 2010 Outlook for Mortgage Rates and the Mortgage Market (emphasis added):

By HSH’s reckoning, the Fed’s involvement in the market means that conforming fixed-rate mortgages are perhaps 75 basis points (0.75%) below where they would be absent the program. This means that we expect interest rates to rise somewhat when the program expires. How much they rise will depend on whether or not private investors will want to buy these investments, and how strong that demand will be is quite unclear at this time. It’s best to plan for at least some increases in interest rates as the end of the program approaches and for some period after March 31, with perhaps as much as a half-point rise to start.

We’ll continue to keep you posted on the latest decisions concerning the Fed’s MBS purchase program.

Should the Fed continue to purchase mortgage-backed securities in order to keep rates low?

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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