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Mortgage rates expected to ease even as Fed vows to continue ‘quantitative tightening’ that’s trimming mortgage holdings by $35B a month
Saying the U.S. banking system remains “sound and resilient,” Federal Reserve policymakers approved what might be the final rate hike in their campaign to fight inflation Wednesday, raising the benchmark federal funds rate by 25 basis points to a target range of 4.75 percent to 5 percent.
Equally significant for mortgage rates, the Fed said it will also continue to withdraw the support it had provided to mortgage markets during the pandemic, letting $35 billion in mortgage-backed securities and $60 billion in Treasurys roll off its balance sheet each month as part of a “quantitative tightening” plan launched last summer.
After the failures of Silicon Valley Bank and Signature Bank, there were some doubts that the Fed would continue the rate-hike campaign it began last year. By pressing forward with at least one more rate hike, Fed policymakers sent a signal that they believe the banking crisis has been contained and that they remain determined to bring inflation under control.
But Federal Reserve Chair Jerome Powell said policymakers will take a wait-and-see approach to hiking rates again, saying events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses.
“It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond,” Powell said. “As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation. Instead, we now anticipate that some additional policy firming may be appropriate.”
The Fed has six more meetings this year, and the so-called “dot plot” — which shows how high members of the Federal Open Market Committee think interest rates will need to go to curb inflation — suggests the Fed will implement one more 25-basis point rate this year.
The dot plot shows Fed policymakers expect inflation to cool, which would allow them to bring the federal funds rate down to 4.3 percent by the end of next year and 3.1 percent by the end of 2025.
Mike Fratantoni, chief economist for the Mortgage Bankers Association, characterized the Fed’s latest move as a “dovish hike, as the commentary and economic projections suggest we may be at or near the peak fed funds rate for this cycle.”
Fratantoni said the MBA is sticking to a forecast that mortgage rates are likely to trend down over the course of this year, “which should provide support for the purchase market. The housing market was the first sector to slow as the result of tighter monetary policy and should be the first to benefit as policymakers slow – and ultimately stop – hiking rates.”
The MBA’s weekly survey of lenders shows homebuyer demand for purchase loans picked up last week for the third week in a row as mortgage rates eased. An unusually wide “spread” between 10-year Treasury yields and 30-year fixed-rate mortgages means mortgage rates could have more room to come down if bond yields stabilize.
Mortgage rates expected to ease
Projected rates for 30-year fixed-rate mortgages | Source: February forecasts by Fannie Mae and the Mortgage Bankers Association
The CME FedWatch Tool, which monitors futures contracts to calculate the probability of Fed rate hikes, put the odds of one more 25 basis-point increase in the federal funds rate in May at less than 50 percent.
Powell emphasized that any future increases will depend on labor market and inflation data.
“We will closely monitor incoming data and carefully assess the actual and expected effects of tighter credit conditions on economic activity, the labor market and inflation and our policy decisions will reflect that assessment,” he said.
In a note to clients, Pantheon Macroeconomics Chief Economist Ian Shepherdson said “In short, the statement, policy action, and dots signal clearly that the Fed is nervous.”
While dot plot shows the median forecast is for the federal funds rate to come down to 3.1 percent by the fourth quarter of 2025, the range of expectations “is massive,” Shepherdson noted, ranging from a low of 2.375 percent to a high 5.625 percent.
“No one knows, in other words,” Shepherdson said.
Fratantoni downplayed the Fed’s commitment to continue quantitative tightening by allowing Treasurys and Agency mortgage-backed securities (MBS) to “passively roll” off of its balance sheet.
The MBA economist said recent increases in direct lending by the Fed through the discount window and a new term lending facility in response to the banking crisis “will help to improve liquidity for banks, despite this ongoing reduction in the size of the Fed’s securities holdings.”
At the height of the pandemic, the Fed was buying $80 billion in Treasurys and $40 billion in mortgage-backed securities each month, “quantitative easing” that helped push mortgage rates to record lows.
Now that it’s focused on fighting inflation, the Fed has been reducing its holdings of government bonds and mortgage debt by not replacing its investments as they mature.
Since reversing course last summer, the Federal Reserve has trimmed its holdings of long-term Treasuries from a peak of $5.77 trillion in June 2022 to $5.33 trillion as of March 15. The Fed’s holdings of mortgage-backed securities, which peaked at $2.74 trillion in March 2022, now stand at about $2.61 trillion.
Fed continues trimming its balance sheet
Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis