The Fed Translated – and why it isn’t good for interest rates…..

by Tom Vanderwell

Mortgage Officer

Author website

My apologies for taking almost 24 hours after the Fed to get this up.   As I’ve done in the past, I want to go through what the Fed said yesterday and give some insights into what I think it means for the housing and mortgage markets.   You can find the entire FOMC statement at Federal Reserve.gov.    As usual, my comments will be inserted inside the statement and will be in bold and italics.   Here goes:

For immediate release

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. I think it’s important to notice that they didn’t say things are improving, just leveling out.   The Fed never uses any words without a reason. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.  I think that what they mean by household spending is stabilizing is that people have slashed and burned their budgets down to the minimum and aren’t cutting back further.   However, if you look at the Retail Sales Report this morning, it raises a question of whether household spending is stabilizing. Businesses are still cutting back on fixed investment and staffing that’s a nice way of saying jobs are still being lost but are making progress in bringing inventory stocks into better alignment with sales. inventory in better alignment with sales – what that really means is that the jobs that “make things” are still being eliminated. Although economic activity is likely to remain weak for a time a time – that’s a nice way of saying we’re in for a long slow climb back, the Committee continues to anticipate “continues to anticipate” is that sort of like, “Please, please please, I really really want it?” that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.  They have had this sentence in there for a substantial length of time.    The longer that they put it in their statements, the more “hollow” it sounds.   Rather than being very confident, it’s starting to sound a bit more like, “We think we did everything right, now we just need to wait and see if the patient will recover.”   Oh wait, it’s 6 months and he’s still in a coma.

The prices of energy and other commodities have risen of late. However, substantial resource slack resource slack is a nice way of saying that we’ve got way too many production facilities and the demand isn’t nearly as high as the available supply is likely to dampen cost pressures – if there are 20 suppliers who are looking to make enough of something that could be done by 16 of them, the 16 that got the work can’t raise prices and the Committee expects that inflation will remain subdued for some time.  For some time – yes, it will.   In my mind, inflation and correspondingly interest rates will remain low for 12 to 18 months.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability we haven’t put any of our tools back in the box yet.  We’re ready to use them if they need to.. 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. As previously announced, important words – this isn’t something new, it’s a restatement of what they have done, 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 up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. 

This is the only real change in the whole thing – they were supposed to be done in September but what they are saying is they will take the rest of August’s purchases and Septembers and spread them out through the end of October.  Now ask yourself, if they anticipated that the wind down of their purchases would have either a good or non-market moving effect, they would have finished up like planned in September.   But they didn’t, they said, “we need to spread it out over an extra 30 days to “mute” the impact to the market.   What sort of impact?   Let’s look at it this way:   If there are 20 buyers and 20 sellers, the demand and the supply is in balance.   If there are 20 sellers and suddenly 1 of the buyers, a relatively big buyer, says, I’m not going to buy any more, things get out of whack.   That means that most likely interest rates on Treasuries are going to go up.   And if interest rates on Treasuries is going to go up, what’s the most likely outcome for mortgages?   If you said, that they’ll go down, you’re wrong.

Now ask yourself, the Fed is buying $1.25 Trillion in mortgage backed securities from Fannie and Freddie.   What do you think is going to happen when those purchases are done?   Yep, higher rates again.

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.