Is the Fed going to start without us?by Keith Gumbinger
The Federal Reserve has signaled its intention to begin tapering purchases of Mortgage Backed Securities and Treasury Bonds (QE3) in the near future. These reductions of support–which have served to keep mortgage rates low–may begin as early as September, even before any of the Fed’s “milestones” are met.
Will the Fed stick to their milestones?
The question remains whether the Fed’s own milestones will be met before they begin tapering QE3. The Fed has revealed a couple of economic signals, or milestones, that could mark the end of QE3:
- An unemployment rate approaching 7 percent
- Inflation running above the Fed’s 2 percent “speed limit” for a period of time
- A consistently strong and growing economy
While inflation isn’t much of a consideration at the moment, we are moving closer to 7 percent unemployment and are seeing at least some signs of economic improvement.
The Fed has said it would like to end QE3 by the time the unemployment rate approaches 7 percent.
The Fed’s own expectations call for a 7.2 to 7.3 percent rate for the year. While we have moved pretty steadily downward from 7.9 percent in January to July’s 7.4 percent, job growth has been rather unspectacular, and the labor force participation rate has remained near recession bottoms. A portion of the reduction has come from fewer people looking for work rather than more necessarily finding it.
If we aren’t making meaningful progress toward 7 percent, the Fed may start the taper, but it may not be substantial, at least not in the beginning.
As we said, inflation is another consideration, although not much at the moment.
The Fed said it would tolerate inflation running perhaps a half-percentage point above its 2 percent “speed limit” before it felt compelled to make changes to interest rates. Currently, “core” inflation is at little more than half that level.
As such, there is plenty of leeway for the Fed to keep QE3 in place for longer, since inflation remains benign for the moment.
Fed’s economic projections
The latest set of projections from the Fed expects GDP growth to run between 2.3 percent and 2.6 percent for 2013. To get there, though, we will need to run a GDP of about 3.8 percent in each of the final two quarters of 2013. Presently, growth is estimated at a 1.7 percent rate, so there would need to be a strong surge for a fair bit of time for us to get there.
While some economic news has been better of late, there are plenty of headwinds that continue to hold us back.
What’s the impact on housing?
Lastly, the Fed “will be waiting to see if the movement in mortgage rates has any material effect on housing,” Chairman Bernanke said. “If we think the mortgage rate increases are thwarting the progress we will have to take additional action.”
What will the Fed do?
Given all this, yes, it still seems likely that the Fed will begin tapering QE3 before too long. To us, it appears that some (perhaps much) of the damage a taper would bring has already been done, given mortgage rates are already well above 2013 lows.