Fed may decide to cut mortgages and other long-term rates
As the Federal Reserve concludes a two-day meeting on Wednesday, it will struggle to know how to respond to opposing forces in the country’s COVID-19 fueled economic crisis.
On the one hand, a resurgence of the virus has already slowed the economy and an even darker winter awaits us. At the same time, the wide availability of a vaccine by spring offers the prospect of substantial improvement.
The Fed has already lowered its short-term interest rate to near zero and pledged to hold it until the economy returns to full employment and inflation exceeds its 2% target “for a while ”- a promise that would likely mean no rate hike. until 2024 or beyond, say some economists.
But Fed officials still have more ammunition, largely related to their massive incentive to buy bonds aimed at keeping long-term rates that affect mortgages and other loans. The Fed’s policy decision, which will be released at 2 p.m. on Wednesday, is expected to focus on those bond purchases – and that could mean slightly lower monthly costs for homebuyers and other borrowers.
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The central bank is also expected to update its economic forecast.
Here’s the breakdown of what the Fed can do:
How can the Fed cut long rates?
The Fed now buys $ 80 billion in Treasury bonds and $ 40 billion in mortgage-backed securities each month, putting downward pressure on long-term interest rates, such as mortgages and mortgage-backed securities. corporate bonds.
The average maturity of the securities it purchases is 7.4 years, according to Oxford Economics. Some economists expect Fed officials to buy the same amount of bonds, but move the mix to those with longer maturities. This would further stimulate the economy by further lowering rates on mortgages, corporate bonds and other types of loans.
Why move bond purchases to lower rates?
COVID-19 is increasing across the country, with cases, hospitalizations and deaths reaching new records. This has led to new constraints for businesses, especially in California and the Midwest. Job growth slowed sharply in November and first jobless claims, a rough measure of layoffs, rose sharply to 947,000 in the week ending December 5.
“The economy really needs more stimulus,” says Oxford economist Kathy Bostjancic.
“Fed officials might view the resurgence of the winter virus as the obvious time to take their last shot,” Goldman Sachs said in a research note.
What’s more, after a months-long standoff, Congress has yet to agree on a proposed $ 908 billion relief plan for unemployed Americans and struggling businesses. And Treasury Secretary Steven Mnuchin recently ended several Fed emergency lending programs, placing a heavier burden on the Fed to support a faltering economy, Bostjancic said.
What’s the argument against taking more action?
Several regional Fed bank chiefs have said congressional tax assistance is what is really needed right now. And lawmakers appear to be closing in on a deal before unemployment benefits for 12 million Americans, the eviction ban and other programs expire at the end of the year.
While those federal dollars can be distributed quickly, the Fed’s maneuvering typically affects the longer-term outlook three to six months later, says Nomura economist Lewis Alexander. By then, he notes, a vaccine will likely be widely available, greatly boosting the economy and reducing the need for more juice from the Fed.
What’s more, mortgage and other rates are already at historically low levels, according to Capital Economics, with 30-year fixed-rate mortgages at 2.71%, based on figures from Freddie Mac.
Of course, lowering long-term rates would further fuel the record bull market by causing investors to move more money from bonds to stocks. But that could increase Fed officials’ worries about a market bubble that will eventually burst, according to Bostjancic.
So what is the Fed likely to do?
“It’s a close call,” Bostjancic said.
She, along with economists at Goldman and JPMorgan Chase, expect the Fed to modify bond purchases to cut rates while Nomura, Barclays and Morgan Stanley predict the Fed will stay firm.
How much would the moves lower mortgage rates?
Some but not that much. Rates are already historically low and the real estate market is booming. A change in the makeup of the Fed could lower mortgage rates by about 15 basis points, lowering the monthly payment on a $ 200,000 mortgage from $ 15, or $ 180 per year, said Tendayi Kapfidze, Lending Tree Chief Economist.
What else could the Fed do?
Many economists are more confident that the Fed will provide more specific guidance on how long it will continue to buy bonds. Currently, the Fed’s statement after the meeting simply says it will continue buying “over the next several months.” Fed policymakers have said they want to provide a more detailed roadmap.
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Goldman Sachs believes the Fed will say it will continue to buy bonds at the current rate until the labor market is “on track” to achieve full employment and inflation is “on track” to. reach 2%. It’s similar to the Fed’s criteria for raising its short-term key rate, but not as rigid. That would likely mean that the Fed will start cutting its bond purchases in 2023, about a year before raising its short-term rate, according to Bostjancic.
Why a bond buying schedule?
Bostjancic says Fed officials probably want to avoid another “tantrum” – a rise in Treasury yields in 2013 when Fed officials unexpectedly signaled that they would start cutting their bond purchases afterwards. the Great Recession of 2007-09.
Additionally, investors now expect the Fed to start cutting its bond purchases in late 2021 or early 2022. Signaling a later start could further stimulate borrowing and encourage Wall Street. , said Bostjancic.
Alexander, however, says the Fed can wait until the outlook is clearer before refining its forecast.
What about the Fed’s economic forecast?
In September, the Fed predicted that the economy would contract 3.7% this year and unemployment would end the year at 7.6%. But the economy has recovered from the pandemic faster than expected, with unemployment already at 6.7%. Goldman Sachs expects the Fed to revise its forecast to a contraction of 2.5% this year and unemployment to 6.8% by the end of the year.
Goldman also expects the Fed to modestly raise its estimate of economic growth next year to 4.2%, up from its previous forecast of 4%. Oxford, however, believes the Fed will lower its estimate for next year, as the effects of the virus spike outweigh the vaccine boost.