The Volume Is All The Way Up On 'Fed Speak'

Why Lenders Hang Their Hats On The Fed’s Every Word

Insider

Contributing Writer

In “the old days,” investors in the bond market, lenders, and loan originators would watch for the money supply figures released every Thursday. Then, attention shifted to the unemployment data on the first Friday of every month. This was how people tracked the health of the American economy and consumer.

Watching the data is every bit as important today as it was then. However, the way the market interprets that data is different today, influenced by the constant parade of Federal Reserve officials speaking around the nation – not only meeting every month or two at the Federal Reserve’s Open Market Committee (FOMC). What should residential lenders know about how we reached this point, and why are the rates borrowers see so dependent on these Fed speakers’ thoughts and actions?

The Federal Reserve System, created more than 100 years ago, is the “central bank” of the United States. Its primary purpose is to enhance the stability of the American banking system. This central bank carries out its mission through the actions of the FOMC, comprising the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and the presidents of four other Federal Reserve Banks who serve on a rotating basis.

Of all the Fed’s activities and announcements, it is those of the FOMC that regularly make financial news headlines, such as the decision to leave rates unchanged in recent meetings. The FOMC does not set mortgage rates, but the same factors that influence its actions also influence mortgage rates. As we move through 2024, it is important to know how the Fed operates and how the market interprets Fed actions. After all, its actions directly impact the interest rates that borrowers see, influencing demand.

It is unquestionable that real estate, housing, and the financing of homes have been core components of the U.S. economy for hundreds of years. Over just the past several years, it quickly becomes apparent how the Fed has taken an active role in moving rates in response to other economic data – like employment rates. For example, the Federal Reserve announced QE1 (quantitative easing) in late November of 2008 with a specific goal: supporting the housing and financial markets by way of large-scale asset purchases. The announcement of the program set off widespread buying in the TBA (To Be Announced, where specific pool attributes aren’t known) markets, and within a month, mortgage rates had fallen by almost one percentage point.

In early 2014, the FOMC was purchasing $85 billion a month in bonds. It was expected to “taper off” the QE1 policy and begin reducing its purchases, thus driving up long-term rates and therefore reducing residential lenders’ volumes. Prices of securities are determined by supply and demand, and ratcheting up demand of securities directly impacts the price. Lenders were worried about replacing income caused by interest rates moving higher and volumes dropping due to the Fed’s activities.

Specifically, the quantitative easing programs had a role in encouraging (or discouraging) the refinance market and the overall economic impact on the nation. However, fears of a recession prompted the FOMC to reverse its plan of gradually raising interest rates and begin lowering rates, causing the 30-year mortgage rate to drop from nearly 5% in November 2018 to 3.5% at the end of August 2019.

“Watching the data is every bit as important today as it was then. However, the way the market interprets that data is different today, influenced by the constant parade of Federal Reserve officials speaking around the nation ...”

Rob Chrisman

The coronavirus crisis in the U.S. triggered a deep economic downturn as people “hunkered down” and increased people’s desire to hold deposits and only the most liquid assets. The Federal Reserve intervened with a broad array of actions to keep credit flowing to limit the economic damage from the pandemic, including large purchases of U.S. government and mortgage-backed securities (MBS) and lending to support households, employers, financial market participants, and state and local governments through 2020 and into 2021.

Lenders, of course, took note of the Fed’s appetite for mortgage-backed securities. In the summer of 2021, the Federal Reserve’s nearly daily purchase of assets, either through buying securities backed by U.S. Treasuries or securities backed by residential mortgages underwritten to Agency standards, had become the center of attention for investors. The Fed’s activities were also of interest to every lender, originator, and borrower. Mortgage rates were low – arguably unnaturally low – in part due to this constant buying. As the years went on, the financial markets grew accustomed to, and began relying upon, the Fed’s moves and the Fed’s speeches, dubbed, “Fed Speak.” Fed officials, for their part, seemed very open to “being on the stump” and speaking about the economy.

Currently the Federal Reserve owns over $7 trillion in fixed-income securities, which, in terms of MBS, includes around a quarter of total MBS outstanding… the proverbial 800-pound gorilla in the MBS marketplace. Should the Fed decide to actively sell its holdings, the laws of supply and demand suggest that prices will drop, and mortgage rates will increase. As any mortgage loan officer (MLO) will tell a prospective borrower, a lower-rate mortgage increases the borrower’s disposable income and ability to buy a home. It is safe to assume that the increase in disposable income garnered by the mass refinancing wave also contributed as a stimulus to the overall economy.

Remember that one of the purposes of the U.S.’s central bank is to increase the stability of our financial system. Sudden moves have the opposite impact. When the Federal Reserve began reducing its billions of daily and monthly bond purchases, long-term rates indeed rose, and lenders struggled to replace this income (when interest rates rise, banks holding the fixed portion of the contract lose money on a mark-to-market basis, meaning, the bank is receiving a lower rate than what the market is offering).

Investors and economists watch any speeches or policy statements from the Federal Reserve for any indication that recent data, including faster-than-expected inflation and slower job growth, will change easy-money policies. MLOs should be aware that many economists expect the Federal Reserve to begin reducing rates some time in 2024, but the Fed has made it clear that it is not in any great hurry. In general, investors expect the Federal Reserve to stay the course in its battle to tame inflation.

We should keep in mind that the reasons that cause the FOMC to act are just as important, if not more so, than the actual actions of the FOMC. The markets look to the Fed as having the best research ability, the best sources of information, and the brightest minds in making decisions. Lenders and the markets using the Fed funds rate is a relatively simple gauge of economic strength or weakness. Although the Fed does not set mortgage rates, the data and logic informing its actions can also move interest rates.