Federal Tapering: Has the Mortgage Industry Already Priced in the Rise in Interest Rates?

Talk to your lender about the best next steps to take, because the market doesn't stand still.

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As the United States pushes its economic recovery forward, housing and the "where should I live?" question weigh heavily on many people's minds. As people wonder whether they can afford homes, the Federal Reserve has announced its plan to reduce the bond-buying program it started at the beginning of the pandemic, the so-called tapering of quantitative easing. This announcement has already translated to hikes in interest rates for mortgages, but there's one key question those who haven't refinanced their mortgage and prospective buyers are asking: Is the recent rise in rates just the market pricing in or anticipating what the Fed is going to do, or are more interest rate rises yet to come?

Understanding Quantitative Easing

Quantitative easing (QE) is a nontraditional strategy or monetary policy that central banks around the world (e.g., the U.S. Federal Reserve) use to keep the economy humming during a time of financial crisis. In a nutshell, the Federal Reserve buys up different assets, such as bonds and mortgage-backed securities. This provides a floor of demand for those assets. Banks and other institutions receive the cash the Federal Reserve has created in return for the assets, which means those institutions have more money to work with and lend to the public.

As a result, lenders can offer lower, more attractive long-term interest rates, and it's easier for people to borrow money — this is the main goal of QE. Because there's more money, institutions — along with investors — can look into acquiring new assets that involve more risk, so quantitative easing also influences asset valuations and shakes up the mix of assets held. And finally, many secondary markets have more economic support, too. If you buy a home and need to fix it up a bit, for instance, then you're probably going to hire carpenters, roofers or other tradespeople. From a social policy perspective, that support is especially necessary now during COVID-19, when so many industries have suffered high job disruption.

Some experts assert that QE carries a risk of inflation because of the way it increases the supply of money. And QE really is an emergency measure. Even so, the Federal Reserve has used it before, perhaps most notably between 2008 and 2014 in response to the Great Recession. During that crisis, the Federal Reserve already had dropped its federal fund rate to zero. It didn't have any additional room for more cuts that would encourage lending. They pulled QE out of their playbook to stabilize the economy, modeling their effort after activity in Japan from 2001 to 2006.

When the Federal Reserve uses QE, it sends the message that it wants to stimulate economic growth. But when it decides to taper its QE buying, it's essentially telling everybody it thinks the economy doesn't need support anymore. Today, during the COVID-19 pandemic, you can take the Federal Reserve's plans to reduce its buying as an indicator that the Federal Reserve believes the economy is going in the right direction.

What the Tapering Means for Your Mortgage

When the Federal Reserve used QE to help the economy during the Great Recession, the markets didn't get a clear message about when the Federal Reserve was going to stop buying assets. People experienced the consequent rise in interest rates as a shock. QE also has the danger of contributing to asset bubbles, which may help explain the run-up in stocks during the current crisis. Home prices soared.

The pandemic QE may be one factor that has driven up home prices. Some officials, such as Senator Pat Toomey, see those results and the risk of inflation and assert there's no justification for the QE to continue. But officials have learned from what happened when they used QE before. This time, the Federal Reserve is arguably being much more transparent with their communication, and the timeline for the tapering is clearer. Tapering might start in November or December and be finished by July 2022. Kathy Jones, head of fixed income at Charles Schwab, anticipates monthly cuts of $5 billion to mortgage-backed securities.

In an article for Northwestern Mutual, Carl Engelking asserts that the risk of federal policy uncertainty is just one of the investment risks people are already accounting for. Similarly, analysts at UBS emphasized the positive earnings that are likely to happen and offset bond yields. They urged people to see the tapering as a "gradual withdrawal of an emergency support measure as conditions normalize."

Although there's still some uncertainty about where valuations — including on housing — will go and what final interest rates will look like, the market is already aware that changes are on the way. Lenders know the overall interest rate will trend upward. Officials predict that the Federal Reserve's benchmark 10-year Treasury will be 1.8% by the end of the year, and the 2021 inflation estimate is at 3.7%. The borrowing rate will fall somewhere between 1.75% and 2% when everything is said and done through 2024.

Determining Your Next Move

Quantitative easing enables the Federal Reserve to stabilize the economy on a temporary basis. It has a direct influence on the mortgage market, as the Federal Reserve purchases mortgage-backed securities, prompts new valuations and causes interest rates on lending to drop. The asset speculation related to QE is a major reason that housing prices have been so high over the past two years.

The recent decision by the Federal Reserve to taper QE should motivate you to refinance or purchase a home before interest rates get higher, assuming it's critical for you to save money or secure a property immediately. At the same time, once the tapering is done, home prices might slow their appreciation or even decline slightly, so if you can wait to make adjustments, you may be able to find a better deal even with more elevated interest rates. Talk to your lender about the best next steps to take, because the market doesn't stand still.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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