Is Mortgage Rate Behavior Back to Normal?

The Fed decreased its target rate by another 75 basis points last week. Along with interest rate cuts, are the Federal Reserve’s other innovative programs having their intended effects? Initial results point to yes.

 
 

The Fed's recent actions are unprecedented. Attempts to increase liquidity through their auction facilities and repurchase agreements involving various asset-backed securities, as well as aggressive Federal Funds and discount window rate cuts, have drawn both praise and criticism.

Torn between their two mandates, promoting growth and controlling inflation, they are currently taking a pro-growth stance. Chairman Bernanke contends inflationary pressures will ease later this year as commodity prices, such as those affecting food and energy, decline to normal levels.

How are Rates Moving?

Because of the pro-growth stance, the target Federal Funds rate has been cut by 275 basis points from September to February. This past week, the Fed slashed rates by another 75 basis points. While this has a greater impact on short-term rates, long-term rates, such as the 10-year, have been largely unaffected by the Fed's aggressive cuts. Mortgage rates are also not moving in correlation with long-term Treasuries the way they have in the past. The spread between the 10-year Treasury and 30-year fixed mortgage reached approximately 250 basis points over the past few weeks. This spread normally sits at 150 basis points.

Are Markets Normalizing?

Recent days show some signs that the market may be normalizing. The key reason mortgage rates have remained high is due to an oversupply of mortgage-backed securities backed by Fannie and Freddie on the market. Over the past week however, Fed actions and Government Sponsored Enterprise (GSE) reform have put confidence back into the secondary market. According to the Wall Street Journal, the spread between yields on bonds backed by 30-year mortgages backed by Fannie Mae and the 5-year Treasury has shrunk back to levels where it stood in late 2007, when a more normal secondary market existed.

These spreads have shrunk because the Fed has agreed to take some of these mortgage-backed securities off of banks' balance sheets in exchange for liquidity. At the same time, GSEs are now better positioned to help the market as capital requirements have been loosened by a third. As these institutions can now add approximately $200 billion in mortgages to their balance sheets and increase market liquidity.

An upcoming Callahan webinar, Think Fast: Navigating a Rapidly Changing Mortgage Market , will address the above issues and more that credit unions should focus on in times of high mortgage volume.

 

 

 

March 24, 2008


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