The Federal Reserve was expected to raise short-term interest rates by 0.5%. Much more interesting to market participants was how the Fed planned to handle the reduction in its investments made in the aftermath of the pandemic.

What you might find interesting is that mortgage prices actually improved following the announcement. If you’re in the market to buy a home or refinance, today’s a great day to lock in your rate.

We break down exactly what happened. Our analysis is in bold.

Although overall economic activity softened slightly in the first quarter, household spending and business fixed investment remained strong. Job creations have been robust in recent months and the unemployment rate has fallen considerably. Inflation remains elevated, reflecting pandemic-related supply and demand imbalances, rising energy prices and broader price pressures.

Although gross domestic product (GDP), the primary measure of economic growth — or lack thereof — actually declined in the first quarter, the Fed appears to be taking this pullback in the economy in stride. He was mainly blamed for starting from an incredibly high point in the fourth quarter.

Very high inventories as well as many imports compared to what we export have largely contributed to lowering the number. However, high imports and lower inventories from where they were mean Americans are buying a lot, which is ultimately a good sign.

Beyond that, many other economic metrics appear to be in good shape. Importantly, household spending looks good for the Fed, as well as business investment, while the jobless rate may not come down much.

The key element the Fed is currently focusing on is the level of inflation. There has been an ongoing imbalance between supply and demand since Americans started spending again after the initial shock of the pandemic, but recent energy price spikes and widespread price hikes across the economy have the eye of the Fed.

Russia’s invasion of Ukraine is causing enormous human and economic hardship. The implications for the US economy are highly uncertain. The invasion and related events create additional upward pressure on inflation and may weigh on economic activity. Additionally, COVID-related lockdowns in China are likely to worsen supply chain disruptions. The Committee pays close attention to inflation risks.

In addition to the human toll caused by Russia’s invasion of Ukraine that cannot be underestimated, it has also upended the global economy. Russia is a major oil producer. While sanctions against the country and boycotts of its oil certainly punish Russia, it also means we need to find other sources. Although efforts have been made to alleviate some of these issues, this has resulted in higher prices at the pump.

Meanwhile, COVID-19 related lockdowns are happening again in parts of China. Since so much is manufactured and exported from there, there are concerns that this will exacerbate existing supply chain issues. Between lingering concerns over oil supply and China, this creates new inflation risks.

The Committee seeks to achieve a maximum employment and inflation rate of 2% in the long term. With an appropriate firming of the monetary policy stance, the Committee expects inflation to return to its 2% target and the labor market to remain strong. In support of these objectives, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1% and anticipates that continued increases in the target range will be appropriate. In addition, the Committee decided to begin reducing its holdings of Treasury securities, agency debt and agency mortgage-backed securities on June 1, as described in plans to reduce the size of the balance sheet. of the Federal Reserve that were released in conjunction with this statement. .

There are two key things investors were considering ahead of this meeting: how much the Federal Reserve would change the federal funds rate and its plan to get some pandemic-era investments off its books.

Starting with the fed funds rate, the Fed raised its target range from 0.5% to 0.75%-1%. The federal funds rate is the rate at which federally insured banks borrow money from each other overnight to meet their obligations. Although this is a short-term rate, this cost tends to be passed on to consumers in the form of higher borrowing costs across a lender’s entire portfolio.

In other words, although the fed funds rate is not directly correlated to mortgage rates, they tend to follow the same general direction. It is important to note that mortgage prices actually fell immediately after the announcement, as this level of rate increase was already expected.

Higher interest rates mean that borrowing becomes relatively more expensive. When this happens, people are more likely to hold onto the money and enjoy higher interest rates on savings accounts rather than continuing to borrow and spend more. Less money circulating in the economy would curb inflation. On the other hand, it can also slow economic growth, so the Fed has a major balancing act.

The other big part of the announcement that investors had their eye on was how the Federal Reserve would handle the removal of assets such as Treasuries and mortgage-backed securities (MBS) from its balance sheet. We’ll focus for the next two paragraphs on the MBS part of this.

MBS underpin mortgage rates. They are sold in the bond market and are considered one of the safest investments as most have an actual or implied government guarantee. However, safe investments often mean a lower rate of return compared to the risk/reward scene if you invest in stocks.

Realizing that housing is an important part of the US economy, the Federal Reserve stepped in early in the pandemic to buy mortgage bonds at high levels and keep rates low, thereby encouraging residential investment. The Fed currently holds more than $2.7 trillion value of mortgage bonds.

He wants to start selling them for several reasons: First, it would give the Fed the ability to do so again in response to a future economic crisis. However, the second potentially more important reason at this point is that house prices are rising at extremely rapid levels. Over the past year, the Case-Shiller Home Price Index is up more than 20%. This undoubtedly contributes to overall inflation.

High levels of year-over-year home price appreciation are likely supported by low interest rates, which have been supported by the Fed. Investors buying mortgage bonds from now on will most likely demand a higher rate of return than the Fed. This will drive up interest rates.

Starting June 1, the Fed expects to sell $17.5 billion worth of mortgage bonds per month. After 3 months, this number will increase to $35 billion per month. If you’re ready to get a mortgage, the sooner you lock in your rate, the better.

In assessing the appropriate monetary policy stance, the Committee will continue to monitor the implications of new information on the economic outlook. The Committee would be ready to adjust the monetary policy stance, if necessary, if risks appear that could hinder the achievement of its 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, as well as financial and international developments.

The Committee examines various factors to assess the overall health of the economy. However, most of the main concerns are about inflation right now.

Voting for monetary policy action was Jerome H. Powell, chairman; John C. Williams, Vice President; Michelle W. Bowman; Lael Brainard; James Bullard; Esther L. George; Patrick Harcker; Loretta J. Mester; and Christopher J. Waller. Patrick Harker voted as an alternate member at this meeting.

Committee members agreed.

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