Fed Just Raised Interest Rates: Now What

Fed Reserve and Mortgage Rates

Recently the Federal Reserve raised rates short term interest rates another quarter point and mortgage rates went....down. What's up with that?

For those who follow this sort of thing not surprising for a number or reasons the most obvious of which is that this hike was already priced in. The Fed just isn't a very good poker player and everyone more or less saw this coming. Additionally, the 30 year mortgage rate is more closely tied to the 10 year bond and from time to time daily stock market fluctuations. (Market goes down and so do rates.) We are also most likely seeing our mortgage rates affected by international demand for safe assets.

So as of last week, we are not much off where the year started for most products from most lenders. Not quite at the historic lows but at 4% plus or minus the housing market not impacted very much. At least not yet.

With another Fed rate hike most likely coming this year, many economists are predicting that we could end up the year at around 4.5% on the 30 year product. That is still well within my prediction that at 5% we start to see changes in the current market. (More on that later.)

Here's What Should Concern You

The Fed is planning another action that could affect mortgage rates: selling off its portfolio of mortgage-backed securities.

During the financial crisis, the Fed lowered short-term rates to zero. In an effort to further stimulate the economy by lowering long-term interest rates, such as mortgage rates, it began buying mortgage-backed securities. Higher demand raises bond prices, resulting in lower yields.

The Fed now holds more than $1.7 trillion in mortgage-backed securities, about one-third of all those outstanding. Now the central bank is looking to get back to a “more normal operating environment,” with a smaller portfolio and holdings only in U.S. Treasuries.

They’re not going to get there all at once. The expectation is that the Fed will begin to lay out a schedule for how they’ll treat their balance sheet over time. This will be another factor putting some upward pressure on mortgage rates.

Why is that?

Let's say that instead of replacing 100% of the holdings with new holdings - ie buying mortgages, the Fed replaces only 75%. As with any supply and demand because they are buying fewer mortgages the higher rate product will get sold. So rates go up.

What Happens When We Hit 5%

This prediction is coming from me, not an economist. My analysis says that at 5% on 30 year fixed, price appreciation may grind to a standstill. Simply put, at the price of properties in the Beach Cities, most Buyers get priced out when we are over 1% higher than 12-18 months ago. 

A few other things happen in that scenario.
  • The home owners who are holding wanting to cash in on even more appreciation start to list their homes.
  • With more inventory we start to see more price reduction and rebalancing of the market.
  • More Buyers who are on the fence jump in before rates or prices go any higher.
Which leaves me where I always wind up in these discussions. First, you can't "time the market". If you are committed to Buying or Selling, the environment may not be any better than it is today.

Second, no one rings a bell at the top or bottom of the market!