The Federal Reserve's Big Surprise

We should clarify that the “Big Surprise” hit most market watchers and pundits, but not all. Indeed, we weren't surprised at all.

We're referring to the Federal Reserve's decision on tapering – which was not to taper. The Fed has been purchasing $85 billion of Treasuries and mortgage-backed securities (MBS) each month for the past year. Most market watchers had expected the Fed to announce it would reduce these purchases by $10-to-$15 billion each month going forward.

The fallout of tapering would have been higher interest rates. With the Fed reducing its demand – mostly of Treasury notes and bonds – interest rates would rise. This is a key reason why interest rates in general, and mortgage rates in particular, have been rising in recent months. Market participants were anticipating tapering and higher interest rates.

But the Fed announced yesterday it wouldn't taper. It's reasoning for not tapering corroborated the reasons we've given repeatedly: a sluggish economy and anemic job growth.

Fed officials will meet again in late October, and tapering will surely be the lead agenda. Unless the economy and job growth materially improve between now and then, we would expect the Fed to stay the current course.

When the Fed announced there would be no tapering, mortgage rates fell, which is to be expected. According to data from Freddie Mac, the 30-year fixed-rate mortgage averaged 4.5% for the week ending September 19 – seven basis points lower than the previous week. We expect mortgage rates to fall further in the coming week.

Looking further afield, we see Freddie Mac's weekly average fluttering between 4.25% and 4.5% going forward. We would be surprised if the average fell much lower, though. We say that because there is still pent-up pressure for rates to rise over the long term.

The point we want to emphasis is that borrowers have been given an opportunity to borrow at a more favorable rate. We recommend not getting greedy. Too often we see borrowers' propensity to extrapolate a developing trend indefinitely.

It doesn't work that way. All it takes is one month of unexpectedly strong economic and job growth data, and talk of taper will once again dominate the credit markets. Should that occur, mortgage rates will very likely head for higher ground.

Since the beginning of the year, we've been warning on the risk of procrastinating. To be sure, mortgage rates are lower this week than they were last week, but we don't think they'll be materially lower next week... or even beyond.

So keep in mind that the long-term imperative is for interest rates to rise, so the risk of procrastinating remains.

Courtesy of Jessica Regan.

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