The end is coming

DeadlineThere was nothing more clear than Chairman Bernanke’s message at the press conference which followed the Federal Reserve’s FOMC meeting last Wednesday.

There were an awful lot of “ifs,” but the market got exactly the message it feared: the end is coming.

“If the incoming data are broadly consistent with [the Fed's] forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year,” said the chairman last week. “And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.”

Why did mortgage rates rise?

At one point during the press conference, when asked about the sharp increase in interest rates recently, the chairman said, “Well, we were a little puzzled about that.”

How could the Fed be puzzled? Markets follow the Fed’s moves. If the Fed is getting out of the bond-buying business, no investor wants to be stuck with low-yielding paper no one wants to buy.

How important are low mortgage rates?

In the months ahead, we’ll see to what extent that the recovery in housing was dependent upon near-record-low mortgage rates. At the very least, the increase in mortgage rates seems sufficient to distort the upward path for home sales and prices.

While there has been some concern recently that some kind of “bubble” was again forming in residential real estate (strong demand finding little available inventory has pumped up home prices), the fact is plain: higher borrowing costs will temper demand, and that tempering of demand should serve to slow home price gains and sales to some degree.

A rate-rise reaction

We saw a rate-rise reaction in existing-home sales in May. Rates started the month just a few basis points from all-time lows, bringing interested buyers into the market.

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Later in the month, mortgage rates drove higher. This kind of a price change often fosters action, and those people actively in the market no doubt pushed to get their deals done before mortgage rates moved even higher.

The cost of higher mortgage rates

In May, the median priced home sold was $ 208,000. Assuming a 20 percent down payment, a borrower who got a rock-bottom rate last month would pay about $ 746 a month.  With a rate of 4.33 percent (last Friday), you would pay about $ 826 each month. The monthly payment is now about 11 percent higher than it was last month. To determine how mortgage rates will affect your monthly payments, be sure to use our mortgage calculator.

With the rise, and all things being equal, a marginal borrower might be pushed out of the market unless home prices back off a little.

Will we even notice this ‘declining’ support?

So the end to QE is on the horizon, with the tapering likely to begin later this year. If tapering began in September and was eliminated by mid-year as Mr. Bernanke noted, that would put on a pace to see reductions of an average of about $ 9 billion per month, give or take.

But would these levels actually constitute as “declining” support?

With federal budget deficits falling, there will likely be fewer newly-issued Treasuries to purchase in the market. With mortgage originations easing and now likely to fall further, there will be fewer new MBS to acquire from Fannie or Freddie. As such, with smaller amounts to absorb, the Fed would remain strongly active in the market, at least on a percentage of the market basis.

Lastly, there’s nothing preventing the Fed from purchasing assets from the open market, so investors might still find a ready place to dispose of low-yielding assets if needed.

HSH Associates Financial News Blog

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