Fed moves forward with plan to lower mortgage rates
by Tim Manni
As expected, the Federal Reserve announced this afternoon that they are moving forward with their latest economic policy dubbed “Operation Twist,” which may lead to even lower mortgage rates.
What is Operation Twist?
Essentially, the Fed is purchasing more longer-term securities in an attempt to keep downward pressure on long-term interest rates, such as mortgage rates.
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A $400 billion “twist” in their holdings will take place by selling instruments with terms of less than three years and purchasing those with terms of six years or longer.
What will this do?
This is intended to influence long-term interest rates lower–mortgage rates are expected to remain low, perhaps falling even more.
From the horse’s mouth
Here’s a portion of the Fed’s statement:
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.
Criticisms
One of the criticisms of pushing mortgage rates lower is that investors have started to show resistance to buying Mortgage-Backed Securities (MBS) with ever smaller yields. This has recently caused a considerable widening in the spreads between Treasuries and mortgage rates.
The Fed’s counter attack
To counter this, and in a surprise twist of its own, the Fed announced that it would again be a buyer for MBS. As the MBS investments it holds in its portfolio are retired (paid off or refinanced), the Fed will re-invest those proceeds into new MBS.
This means that there will be a willing buyer for these low-yielding investments, and that should provide some additional downward pull on mortgage rates in the coming months.
This is a departure from existing policy.
The Fed had previously announced that they wanted to let their mortgage holdings run off over time and they were going to return their investment mix back to 100 percent Treasury offerings over time. This was announced after the Fed meeting on August 10, 2010.
Fed funds rate
The target range for the federal funds rate will remain between 0 and 0.25 percent for a long time to come (Fed says they expect the fed funds rate to remain exceptionally low through 2013).
