The Federal Reserve’s Federal Open Market Committee (FOMC) concluded its last policy meeting of 2021 yesterday. The Committee had several interesting things to say, but perhaps the most important thing to start with is its assessment of the future.
Once a quarter, the FOMC projects where it thinks various economic indicators and interest rates will be in the near term and over the next several years. Some projections included are the unemployment rate, inflation rates and economic growth as measured by gross domestic product.
The key indicator that interest rate trackers pay attention to is the federal funds rate projection. In his latest screenings, the Committee estimates that the federal funds rate will be somewhere between 0.6% and 0.9% in 2022. This projection is important because the FOMC controls the federal funds rate.
The federal funds rate is currently in a range of 0% to 0.25%. Assuming the Fed follows the path it has taken in recent years, the Committee generally likes to raise the rate. 25 basis points (0.25%) at a time, that means two or possibly three rate hikes depending on whether the fed funds rate is in the low or high projections. Of course, it all depends on how things go with the economy.
If you are looking for a mortgage, this is important because the federal funds rate is the rate at which banks borrow from each other overnight. While not directly correlated, this rate tends to impact long-term rates for things like mortgages.
This brings me to the Fed press release. One of the things the Committee mentioned is that it will reduce the Fed’s purchases of Mortgage Backed Securities (MBS) more quickly. The Fed has been the biggest buyer of MBS for some time.
The volume of Fed buying was such that mortgage rates were able to fall because the yield on the underlying bond did not have to be that high to attract an investor. As the Fed slows down its buying, yields will likely need to rise to attract buyers. If that happened, mortgage rates would go up.
What does all this mean in concrete terms? If you’re currently looking for a mortgage, take action if you see rates that appeal to you. No one ever knows for sure how the market will go, but all indicators are pointing upwards, so if you are ready, apply now!
The press release is below. My analysis is in bold.
The Federal Reserve is committed to using its full range of tools to support the US economy during these difficult times, thereby promoting its maximum employment and price stability goals.
It’s the same opening paragraph that’s been in every statement since COVID-19 hit U.S. shores. Basically we are still locked in a fight and the Federal Reserve is going to do everything in its power to support the economy.
Thanks to advances in immunization and strong political support, economic activity and employment indicators continued to strengthen. The sectors most affected by the pandemic have improved in recent months but continue to be affected by COVID-19. Job gains have been solid in recent months and the unemployment rate has fallen significantly. Supply and demand imbalances linked to the pandemic and the reopening of the economy continued to contribute to high levels of inflation. Overall financial conditions remain accommodative, partly reflecting policy measures aimed at supporting the economy and the flow of credit to US households and businesses.
The most important thing in this paragraph might be what’s not there. The word “transient” has been deleted. While most economic indicators have shown real improvement, it is recognized that the problem of inflation is real and needs to be addressed. At the same time, the Federal Reserve says financial conditions remain good for those looking to get credit, whether it’s a household or a business.
The trajectory of the economy continues to depend on the evolution of the virus. Advances in immunization and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, particularly due to new variants of the virus.
COVID-19 continues to be a controlling factor. The Fed is counting on two things: First, it hopes that increasing immunizations will make people comfortable doing the everyday things that run the economy. Second, it relies on the fact that as supply becomes available this has a dampening effect on inflation. However, a lot depends on what is going on with the virus.
The Committee seeks to achieve a maximum employment and inflation rate of 2% in the longer term. In support of these objectives, the Committee decided to maintain the target range for the federal funds rate between 0 and 1/4%. As inflation has been above 2% for some time, the Committee expects it to be appropriate to maintain this target range until labor market conditions have reached levels consistent with estimates of the economy. Maximum Employment Committee. In view of the trend in inflation and the continued improvement in the labor market, the Committee decided to reduce the monthly pace of its net asset purchases by $ 20 billion for Treasury securities and $ 10 billion for agency mortgage-backed securities. Starting in January, the Committee will increase its holdings of treasury securities by at least $ 40 billion per month and agency mortgage-backed securities by at least $ 20 billion per month. The Committee believes that similar reductions in the pace of net asset purchases are likely to be appropriate each month, but is prepared to adjust the pace of purchases if changes in the economic outlook warrant. Outstanding purchases and holdings of securities by the Federal Reserve will continue to support healthy markets and supportive financial conditions, thereby supporting the flow of credit to households and businesses.
The decision paragraph is the longest paragraph in any Federal Reserve statement and there is always a lot of information, but it seems especially true for this month. Let’s break this down into about five paragraphs.
First, the Committee wants to have annual inflation of around 2% per year. Having a little inflation encourages people to buy now rather than wait, which creates jobs and pushes more money into the economy. Inflation is currently higher than that and the Committee devotes the remainder of this section to how it will tackle the problem.
One of the levers the Federal Reserve has to control inflation is the federal funds rate. Currently, the rate remains at 0% – 0.25%. As we mentioned earlier, projections for next year point to at least a few minimum rate hikes. This will make it more expensive for banks to obtain cash and therefore less easy for consumers to borrow as the increase is passed on.
However, this forces the banks to treat the money they have as if it is worth more, so that you could get more interest on your savings account. This also has the effect of moderating inflation.
The Federal Reserve also bought a ton of Treasuries and MBS in an attempt to keep mortgage interest rates low, among other things. This keeps rates low, but it has also contributed to soaring house prices and higher inflation. The Committee is doubling the pace of reducing treasury bill and MBS purchases in an attempt to slow inflation.
There are really two things to remember here if you are in the mortgage market: if you are ready to buy or refinance now, it might not be a good idea to wait and hope rates drop again. . Second, if you are planning to buy a home at some point, it’s not that bad. As sellers adjust to a higher rate environment, the pace of price increases will likely slow down to provide relief.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of the information received for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy if necessary should any risks arise that could hamper the achievement of the Committee’s objectives. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflationary pressures and inflation expectations, and financial and international developments.
The Committee recalls that all this depends on the future direction of the economy and that it is ready to make the necessary changes. COVID-19 continues to be a priority, but the Committee will also examine labor markets as well as price pressures, both real and expected. Finally, it will examine financial markets and global conditions.
Jerome H. Powell, chairman, voted for monetary policy action; John C. Williams, vice-president; Thomas I. Barkin; Raphaël W. Bostic; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Mary C. Daly; Charles L. Evans; Randal K. Quarles; and Christopher J. Waller.