Fed day is coming up on Thursday. The Statement will be released at 2:00 ET, and Fed Chair Yellen’s press conference will follow at around 2:30 ET. Fed members appear divided about raising the federal funds rate at this meeting. Investor expectations are mixed as well. With no apparent consensus, whatever the Fed decides will likely cause a significant reaction in the markets. More important than the decision about hiking rates may be what investors learn about the Fed’s view of the economy and how that may influence future Fed policy. What impact will this Fed meeting have on mortgage rates? The answer is not at all clear. It will depend on how the Fed’s decision and comments alter investors’ outlook for future Fed policy.
What is likely to happen to mortgage rates tomorrow after the Fed statement is released? The best answer is that it will be extremely volatile. The majority view is that the Fed will begin to taper its bond purchase program, but the reaction in the mortgage market will depend on the details. The first question is the size of the reduction. Investors expect the Fed to cut its monthly purchases from $85 billion to around $70 billion. It is also uncertain how the reduction will be split between MBS and Treasuries. We would not be surprised if the Fed cut only Treasury purchases and left MBS purchases unchanged, since several Fed officials have stated that MBS purchases provide a greater boost to the economy than Treasury purchases. In addition, it will be important to hear how the Fed plans to determine future reductions. Of course, there is no guarantee that the Fed will announce a taper on Wednesday at all. Investors have taken positions based on their expectations for the Fed statement, and there likely will be a large reaction tomorrow afternoon following its release.
There was very little change in today's Fed statement from the prior statement released on June 19. Investors viewed this as good news for MBS, since the most likely potential changes would have been negative for MBS. For example, some investors thought that the Fed would provide more concrete guidance on the timing to begin to taper its bond purchases. Instead, by avoiding specifics, Fed officials left the timing more open-ended. A decline in the quantity of Fed bond purchases will be negative for MBS. The primary change to the statement was the Fed's description of the economy. The statement said that the economy is growing at a "modest" pace, while the last statement said that the pace of economic growth was "moderate". The statement noted that Fed officials expect inflation to rise moderately over the medium term, but that there is a risk that it will decline to undesirable levels. The consensus view is still that the Fed will begin to taper its bond purchases in September, unless economic growth weakens significantly. Friday's Employment report will be one of the major upcoming data points which will influence future Fed policy.
A couple of months ago, Fed Chief Bernanke was answering questions about the Fed's plan to sell its MBS portfolio. He stated that the Fed would eventually return its balance sheet to normal by selling the $1.25 trillion in MBS it had bought to stimulate the economy, but that it would not take place soon. While some Fed officials were pushing for a faster start date, investors believed that the MBS sales were likely to begin early in 2011. As the economic outlook has grown weaker, however, the Fed's likely plans have changed. Rather than discussing a start date for Fed tightening moves, Fed officials are now outlining options and conditions for adding further monetary stimulus. In particular, the Fed had been planning to allow the MBS in its portfolio to mature without replacing them. Due to defaults, refinancings, and maturities, some MBS "roll off" the Fed's portfolio over time. Until recently, investors expected the Fed to let its portfolio slowly shrink in this fashion, which would represent a minor amount of monetary tightening. Tuesday, though, a Wall Street Journal article suggested that Fed officials are considering whether to replace those securities to stimulate the economy. With the next Fed [...]