Diving Deep Into the FOMC Statement. How Does It Affect Mortgage Rates?
Although this may not be necessary, I am going to over-analyze the FOMC statement and relate it to mortgage rates.
Below is the FOMC Statement. I highlighted the adjustments and additions the FOMC made today….
Release Date: November 4, 2009
For immediate release
Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
No Voters Dissented.
The first change of the text is in the opening sentence. The September statement read: “Information received since thernFederal Open Market Committee met in August suggests that economicrnactivity has picked up following its severe downturn”. Today's statement added “has continued” and the removed “following its severe downturn“.
The Fed is telling us that economic stabilization has continued to build momentum since the last meeting. Adding to that point was the removal of “severe downturn“. If we wanted to really speculate on the psychological game the FOMC is playing with the market, I suppose one could interpret this text subtraction as the Fed's attempt to shift perceptions from severe downturn fear towards confidence in the stabilization. You know…”forget about what happened in the past, lets move forward now!” Again…I am reaching.
The next few updates expand on two sentences from the September statement andrnadded what I will refer to as “hesitantly optimistic” verbiage into today's release.
The September statement read: “Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.”.
Today's statement read: “Activity in the housing sector has increased over recent months. Household spending appears to be expandingbut remains constrained by ongoing job losses, sluggish income growth,rnlower housing wealth, and tight credit. Businesses are still cuttingrnback on fixed investment and staffing, though at a slower pace; theyrncontinue to make progress in bringing inventory stocks into betterrnalignment with sales.“
First and foremost, the addition of “improved further, on balance, over the intermeeting period” is the Fed's way of saying stock, bond, and money markets continue to improve. Later in the release the Fed clarifies that these improvements are a function of government intervention, stimulus, and record low Fed Funds rates..and they expect that to continue. No big deal here…until you read on.
The next change is the “hesitantly optimistic” verbiage I was referring to….specifically the removal of “seems” in the statement “houshold spending seems to be stabilizing” and the addition of “Household spending appears to be expanding“. Although the term “appears” implies hesitancy, the FOMC thinks consumers are spending money! When you piggyback this alteration with the “improved further” update, it implies the government's stimulus efforts combined with an efficiently operating financial market isrnleading to better money flow to the consumer level, which may resultrnin more disposable income and increased consumer spending. However we must point out that while the Fed is “hesitantly optimistic about spending, they did NOT remove their “butt covering” verbiage, specifically: “but remains constrained by ongoing job losses, sluggish income growth,rnlower housing wealth, and tight credit.”
I view this change two ways. It will either be the foundation of the FOMC's verbiage that eventually reads: Consumers are spending normally again OR it will evolve into their “sorry consumer spending has slowed and we are nervous about another economic downturn”.
I am going to skip over the next statement change and jump to the last one.
Today the Fed reduced the amount of agency debt they will purchase from $200 billion to $175 billion: “aboutrn$175 billion of agency debt. The amount of agency debt purchases, whilernsomewhat less than the previously announced maximum of $200 billion, isrnconsistent with the recent path of purchases and reflects the limitedrnavailability of agency debt.”
This is the debt of agencies like Fannie Mae and Freddie. These debt issuances raise the funds the agencies need to run their operation. The phrase “reflects the limited availability of agency debt” just means that the agencies are issuing so little debt that the market's demand alone will keep agency debt rates stable enough to allow the Fed to exit from the program sooner than expected. This is exactly what the MBS market needs, unfortunately the MBS market also need a government guarantee to attract enough investor demand to keep mortgage rates stable. This change is more of an FYI than anything (although agency debt spreads did widen after the announcement).
The next update is the BIG ONE.
The FOMC made an addition to the September text that read: “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period“.
Don't panic, the Fed did not change the all important “extended period” verbiage, that was left alone (short end of the yield curve says “phew”.)Here is the addition:
The Committee will maintain the target range for the federal funds raternat 0 to 1/4 percent and continues to anticipate that economicrnconditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
I left it highlighted and bold because I believe this is the most important alteration the FOMC made to the statement. Why? Because if the listed economic “conditions” stop warranting “exceptionally low levels of the federal funds rate”…the market will react on its own.
The Fed is telling us the following: If the rate of inflation increased or the market's inflation expectations start to worsen (market thinks prices are going to rise) OR if resource utilization improves..the FOMC will have to start considering rate hikes.
Resource Utilization: the inputs that go into goods and services production like PEOPLE, machines, tools, warehouses, trucks, trains, planes, working capital are used being used efficiently…specifically LABOR.
Essentially the FOMC is saying “if this happens” you should prepare for us to raise the Fed Funds rate. Unfortunately we wouldn't have to wait for the FOMC to raise rates though, if econ data implies the FOMC metrics dont warrant “exceptionally low rates”….the bond market, currencies, commodities, and equities will automatically price in a Fed rate hike. View it as a self-policing mechanism for the marketplace.
What Does This Mean for Mortgage Rates?
For the bond market, even heavy speculation that the Fed was going to raise the Fed Funds rate would cause mortgage rates to rise. The the carry trade going on in the short end of the yield curve would come to an end (FAST), 2yr note yields would rise, and the long end of the yield curve would sell off as inflation expectations grew. Not good!
We will be intently monitoring manufucaturing data, labor market data, the Fed's preferred inflation indicator (the PCE)…and most importantly, the market's perception of it all.
Plain and Simple: the labor market needs to turn around fast for us to get really concerned about a rate hike OR the dollar would have to continue to weaken and the cost commodities would have to skyrocket to PUSH inflation higher (called COST PUSH INFLATION). The latter is a bigger concern than the former.
Economic uncertainty persists…but what matters most is what the market THINKS the Fed is going to do.
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