If you presently have a mortgage, your mailbox has no doubt been inundated with fliers from mortgage lenders advertising extremely low rates. And it’s true: the days of the 3% mortgage are back. But less than a month ago, most experts were predicting a steady increase in rates. What happened? How did we get back to the 3% mortgage, and how long can we expect to stay here? The answer lies with the Federal Reserve, their quantitative easing program, and the projected performance of the US economy.
As a brief refresher, the Federal Reserve began its policy of Quantitative Easing (QE) in the immediate aftermath of the 2008 housing collapse and subsequent recession. Because interest rates had been effectively zero since 2006, the Fed had limited options to stimulate the economy. Typically, the Fed reacts counter-cyclically to extremes in the economy: they will raise the interest rate to cool an overheated economy or lower the interest rate to stimulate a dragging economy. Since the prime interest rate determines how expensive it is to borrow money, cheap money will provoke increased economic activity and vice versa.
QE is a method of artificially lowering the cost of credit by purchasing longer-maturing debt, like Treasuries, and thereby keeping rates low while simultaneously expanding the monetary base. The Fed is in the middle of its third round of QE. It had pledged to purchase a set amount of mortgage-backed securities each month until the US economy reached certain inflationary and employment goals. Throughout 2014, the Fed signaled that they would begin ‘tapering’ their bond purchases on account of the unemployment rate dropping and inflation remaining well below target.
However, recent economic news has not been encouraging. Wages and average hours worked have remained stagnant; the number of jobs being created is sub-par considering we’re 6 years out from the recession; oil prices are dropping; retail figures are week; and Europe is once again making headlines for the fiscal catastrophes set to erupt in Greece, Ireland, and Spain.
Responding to this news, the Fed has been less forceful with its insistence that it will begin tapering. Some experts are even speculating that they will be forced to institute a fourth round of QE—although that seems unlikely. They’re far more likely to avoid shocking the economy with a sudden taper in asset purchases. This is what investors are expecting and is why Treasuries recently dropped 20 basis points overnight. Speculation that the Fed will continue buying mortgage-backed securities coupled with capital flows from under-performing economies like Japan and Germany are depressing bond yields and will continue to do so until the picture improves.
As Yogi Berra said: “Predictions are hard—especially about the future.” Nobody knows what the future will bring. Just a month ago, everyone was certain that we were on the brink of a great recovery. Now everyone has retreated to a state of pessimism. Domestically and internationally, events are unfolding that demand appropriate reactions from the Fed. Everything seemed to have been contained until earlier this week; suddenly, we are getting bad news from all corners. Nobody knows how long the present bout of bad news and low rates will last, but I do know one thing: it won’t last forever. If you missed out on the historically lows rates of 2012 and 2013, now is your chance to take advantage them.
10-11-2014 Infinity and Beyond