Fed’s tapering to aim at ensuring housing recovery

Mortgage Rates

Freddie Mac reported today that the average rate on a 30- year fixed-rate mortgage rose to a two-year high of 4.51 percent in the week ended July 11 from 3.31 percent in November.

Most economists surveyed by Bloomberg on June 19-20 said the initial tapering by the Fed will include a reduction in Treasury purchases as well as mortgage bonds, with 36 percent saying the larger cutback would be in Treasuries, 26 percent saying MBS and 38 percent predicting they would be pared equally.

The FOMC said at its most recent meeting it will continue buying $40 billion in mortgage bonds and $45 billion in Treasuries each month until the labor market “improves substantially.” The committee also pledged to keep the main interest rate near zero so long as the unemployment rate remains above 6.5 percent and the forecast for inflation doesn’t exceed 2.5 percent over one to two years.

No Selling

Most participants in the June meeting expect that the Fed “would not sell agency mortgage-backed securities” that it already holds as it scales back quantitative easing, according to the minutes. The minutes didn’t reflect any discussion on whether tapering of asset purchases would concentrate first on either Treasuries or mortgage bonds.

Williams told reporters May 16 that mortgage bonds have been a particularly effective tool for Fed stimulus.

“The recovery in home prices has all sorts of beneficial effects,” including “making you feel wealthier,” Williams said. “Many people have responded to their improved finances by spending more on a range of goods and services.”

Rosengren has been more explicit, telling Reuters on April 15 that the Fed should reduce Treasury purchases first.

The importance of housing to the recovery may shape the initial tapering, said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore who worked at the Fed’s division of monetary affairs from 2004 until 2008.

QE Skeptics

“The center of the committee would probably like to taper Treasuries first, but it is a committee that likes to try to achieve consensus,” he said. “The motivation would be not to snuff out the rebound in housing. My guess would be they taper both but maybe a bit more on Treasuries.”

Several Fed presidents including Richmond’s Jeffrey Lacker, Philadelphia’s Charles Plosser and Dallas’s Richard Fisher, who have been skeptical of the effectiveness of quantitative easing, have urged that Fed move away from mortgage-backed securities because the holdings amount to targeting a particular industry.

“It is true the Fed thinks the MBS has been quite instrumental in lowering of mortgage rates,” said Millan Mulraine, director of U.S. rates research at TD Securities USA LLC in New York. “The Fed has to weigh that against the fact that over time it wants to move to an all-Treasuries portfolio.”

Some on the FOMC say buying mortgage securities “is a misguided policy and making a credit allocation decision for the Fed,” Mulraine said. “They are going to draw the line between” Treasuries and mortgage bonds.

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