Interest Rates Edge Up

Interest rates edged up just a bit last week .The following are excerpts from the newsletter on interest rates published by HSH Associates :

“Nothing lasts forever, not even stimulative monetary policy. It may last for a while, perhaps even an extended period, but will eventually go away. The open question, unanswerable at the moment, is “when?”

Minutes of the latest Federal Reserve Open Market Committee meeting released this week from the Fed’s January meeting revealed at least this much: Even the Fed isn’t sure.

Recently, date-based targets for policy changes have been replaced with benchmarks for joblessness and inflation. While there is general agreement that this is a good thing, some on the Fed’s policy-setting committee see QE3 tapering or ending as soon as the second half of this year, some at the end of 2013, and some perhaps not until mid-2014 at the earliest.

However, there is some discussion that the size of the program, presently some $85 billion per month, may be modified from time to time as market conditions warrant. The Fed is going to discuss whether such a changeable program is suitable at its next meeting in March. To the extent that the Fed lessens its purchases of Treasuries and MBS, mortgage rates may be affected and pushed upward as a result, but to us that doesn’t seem to be coming in the immediate future.

Eventually, Federal Reserve policy will move from that of extraordinary to more typical, where movements in the Federal Funds and Discount Rates will be the primary tools in play. That may be years away at this point, but a Federal Reserve should be adaptable when it comes to adjusting policy. Frankly, if the economy doesn’t need the additional stimulus at some point, it would be inappropriate of them not to begin to remove “accommodation” in whatever form it may comprise. Of course, market participants would prefer some certainty — finite beginnings and ends of programs, changes only coming when the attainment of goals are reached, etc. — but stated or projected Fed policy has rarely provided such absolutes.

We are given to wonder what will come of the housing market — sales and prices — when interest rates eventually return to normal. When we first created this chart in February 2011, the ten-year and five-year average rates were on either side of 6%. After two years of unbelievably low rates, those have been pulled down by a considerable amount. The monthly cost of borrowing $1,000 at the 10-year average is $5.65; the same $1,000 over the last five years cost $5.26 on average. Presently? The monthly cost per $1,000 borrowed is a scant $4.60 — and moving back to even that 10-year norm would see a 23% increase in cost. Rising costs of financing must be borne either by rising incomes or offset by lower home prices if affordability is to be maintained. As such, the Fed may have a bit of a delicate dance as it exits its program of extraordinary support, since some damage to the housing market is possible, if not likely.

That said, and with the fact that the Fed has literally just embarked on this path (started seven weeks ago) it’s premature to worry about the program’s end. The economy remains in a modest growth pattern at best, with scant signs of the kind of acceleration which might hasten the end of QE3.

Amid all of this, mortgage rates are about flat. We did move up to present levels a few weeks ago, climbing from December’s record lows, but there doesn’t seem to be enough economic oomph to move us any higher. Some doubts about the strength of the stock market rally have surfaced over the last week or two, and concerns that the Fed might end the liquidity party sooner than expected did certainly cause a halt in stock gains earlier this week. The influential 10-year Treasury managed to slip below the 2% level toward the end of the week, putting a lid on the small rise in mortgage rates.

We would expect next week to be more of the same, with just enough good news to keep rates from falling, but not so good as to engender any serious rise, either. As a result, rates will wander around with little expected change by the end of the week.”

The following are interest rate quotes by Al Hermann of American California Financial: