As widely expected, the Fed raised the federal funds rate by 25 basis points. Unfortunately for MBS, Fed officials also raised their outlook for the pace of future rate hikes. They now forecast three rate hikes in 2017, one more than previously projected. The faster pace was viewed as negative for mortgage rates. But why? The purpose for raising the federal funds rate is to keep inflation from rising above the Fed's target of 2%. This should be a good thing for mortgage rates. Part of the reason for the adverse reaction stems from a more direct effect the Fed has on mortgage rates. The Fed owns over $1.7 trillion of the agency mortgage-backed securities (MBS) that it purchased during its quantitative easing (QE) days. The Fed keeps the balance of MBS around that level by buying new MBS to replace that which pays off. The Fed is currently the buyer of approximately 25% of all newly issued MBS. This added demand from the Fed drives MBS prices higher and mortgage rates lower. The Fed says that it will not allow its holdings of MBS to decline until "normalization of the level of the federal funds rate is well under [...]
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.