Yesterday Chairman Ben Bernanke announced that the U.S. economy is improving and the unemployment rate should accelerate downwards towards a 6.5% level this year. This benchmark is important as the timetable when the Federal government will begin tapering its purchased of $85 Billion per month in government securities, which has been backing about 90% of the residential mortgages being offered this year.
The Fed says it will keep buying $85 billion a month in bonds until the outlook for the job market improves substantially. It’s maintaining its plan to keep short-term rates at record lows at least until unemployment reaches 6.5%, or inflation goes to 2%, which is not likely to happen.
You have to hand it to the Fed — they can raise interest rates without tapering and without raising rates themselves.
How much did our rates go up? Well, it appears to be somewhere between 60-70 bps initially. I saw quotes today at 3.85% for refinances and 4.15% for new construction.
If the $85 Billion continues to be purchased, why did they go up at all? It all is based on expectations. Say you are a bond investor buying a d (4) security last Friday, at say, 3.50%. Today, you know that soon, sooner than expected last week (when you expected rates to start moving up in early to mid-2014, you, the higher rates are likely to kick in when the Fed removes its support. You demand more yield going forward, like anyone would.
There is another issue: Our securities are put into mortgage back instruments that are sold in tranches. On the short end of the security, there is an expectation that prepayments will be according to a schedule. Now, with rates going higher, one cannot anticipate an early prepayment of those low rate securities that were included in the REMIC. The result is a demand for higher yield going forward.
Is there any ray of hope for interest rate sensitive transactions in the short term? It depends upon when you have to buy funds. Rates when they move typically spike, followed by a see-saw period when they either lower or rise based upon the bias. There is a good chance that the events of today are an oversold market that will gain some perspective and rationality going forward. Do I expect rates in the low threes? Not anytime soon, but give me a moment to share some cynicism.
The economy is improving in large part due to the stimulus. If the stimulus goes away, what happens? I think that rates will go up and industries like construction will suffer, as will any interest rate sensitive business. That will keep the unemployment up and provide at least a counter balance to those who want the stimulus to end. Secondly, our business always does better when the economy has a slight cold. We don’t want dire economics but when rates are low, given economic doldrums, more deals work.
I could be wrong, and I have a track record to prove it, but the stimulus has been important for most of the economic improvement to my thinking. Take it away and at least for a time, there will tentative to mediocre economic improvement (maybe worse).
If you look at what the Fed Chairman said, he is going to continue buying until the unemployment rate improves. That is what we know.
Over time, if that improvement subsides, given its lockstep to the stimulus, one can expect some rate easing in the market place, at least for a little while.
If you have been waiting to finance, you are now on notice that closing time for the party is getting nearer.