Mortgage rates have been on a tear lately, and by that we mean they've been rising at a precipitous pace. The rise in the 30-year lending rate has been particularly steep.

Many markets are seeing the highest lending rates of 2013. Other markets are seeing the highest rates over the past 12 months. So what's going on; why the dramatic increase?

Most market commentators point to the Federal Reserve, and when they point to the Fed they frequently invoke the word “tapering,” which refers to the Fed withdrawing from the mortgage-backed securities (MBS) market. Over the past couple months, the Fed's MBS purchases have declined modestly. At the same time, a growing cadre (though still a small minority) of Federal Reserve bank presidents have expressed the need for the Fed to cease purchasing MBS.

The market's reaction has been to sell fixed-income investments, which has caused yields to rise, including the yields of MBS. Because mortgages are the source assets in MBS, it's only natural that mortgage rates have also risen.

Rising rates have taken some steam out of the refinance market. After two sharp weekly declines, refinance applications fell another 12% nationally last week, according to the Mortgage Bankers Association. Refinance activity is the lowest it has been all year.

Purchase application activity has shown more resilience. After falling moderately in the prior two weeks, purchase applications rose 3% in the latest reported week. The fact that purchase activity hasn't been muted by rising rates is reflective of strong housing demand and a strengthening economy.

In the days before the Federal Reserve was active in the mortgage market, rising rates would spark an increase in activity for fear of rates moving higher still. Today, many market watchers expect a rate increase to be followed by a pullback, believing the Fed will again intervene to reverse a rising trend.

Those who head for the sidelines when rates rise might be on to something. To be sure, we believe that higher rates are in our future, but not necessarily in our immediate future. In other words, the thesis behind “tapering” could be overdone; it's not that the Fed is withdrawing from the MBS market, it's that there were simply fewer MBS for the Fed to buy.

We say that because we experienced a lull in mortgage loan originations in March; fewer mortgages means fewer MBS the Fed could buy. But in April, we saw a burst of refinances. Many of these loans will have closed in May, which will lead to more MBS coming to market, and more MBS the Fed could buy.

In short, we're not sold on “tapering” as the Fed's new de facto monetary policy. We need to see a couple months of evidence before jumping on the bandwagon. So don't be surprised if lending rates reverse course and revert to lower ground in coming weeks.


 Courtesy of Jessica Regan.

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