I know I have said it many times before, but the party has to end sometime, and it would appear that Janet Yellin, the new chair of the Federal Reserve, is turning up the lights and turning off the music in a clear message that it’s time for everyone to go home and sober up, and there might just be some very nasty hangovers from the past several years of uber-low interest rates.
This week, the Federal Reserve rocked the bond and stock markets by coming out and stating that rates might increase sooner than anticipated, although the message was typically vague as to exactly what that meant, and there are no end of opinions as to what, when and how much all this will entail.
Federal Reserve Bank
To remind all, the Federal Reserve Bank (which by the way is actually not a government institution and is actually owned by the private banks in the U.S., although the chairman of the Fed is appointed by the president and the bank is chartered by Congress) does not actually set mortgage rates. They do, however, set the rate at which banks can borrow money from the Fed, and that influences the rates the government pays on treasury bills which tends to push mortgage rates up and down. One way the Fed does this is to cut back its program of buying mortgage backed securities, which will reduce demand and push the price of a security down while increasing the yield the security pays. When the yield goes up, mortgage rates go up.
So when the Fed says that interest rates must rise, it’s big news because investors must decide how to invest their money to get the best rate, and if the Fed is backing out of mortgage backed securities (which is where money to fund mortgages comes from), then the value of those securities that investors hold will drop and to generate more money for mortgages the rates borrowers pay will have to go up.
On Wednesday after the Fed made its announcement, the bond markets were in chaos for several hours, with prices on bonds falling as much as a full percentage point briefly. That is more movement than we have seen in the past several months combined, and mortgage rates shot up accordingly, as much as 1/4 percent overnight.
For once, I think this is a long term trend, not just a blip. While the economy has brought a lot of pain and suffering to way too many people, we as a nation have been on an IV high of cheap mortgage money, and that has bred false expectations about the long-term sustainability of mortgage rates below 5 percent.
For the first 12 years I was in the mortgage industry, rates were between 6 and 8 percent, and somehow we all got along just fine and prospered. Certainly the low rates (which hit 3.5 percent for a 30-year fixed about a year ago) have been fun, but I have always dreaded the reality check the general public would go through once reality returned.
My prediction is we will see rates in the low 5 percent range by the end of the year, and if the economy continues to strengthen, then it could go to the mid 5 percent range by mid-2015.
Chris Neuswanger is a loan originator at Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers. His blog and a collection of his columns may be found at www.mtnmortgageguy.com.