The Federal Open Market Committee (FOMC) of the Federal Reserve concluded its final policy meeting of 2021 yesterday. The Committee had several interesting things to say, but perhaps the most important thing to start with is its assessment of the future.
Once a quarter, the FOMC projects where it thinks various economic indicators and interest rates will be in the course of the near term and the next few years. Some projections included are the unemployment rate, inflation rates and economic growth as measured by gross domestic product.
The key indicator paid attention to by those who follow interest rates is the federal funds rate projection. In its latest projections, the Committee says it thinks the federal funds rate will be somewhere between 0.6% – 0.9% in 2022. This projection is important because the FOMC is in control of the Fed funds rate.
The federal funds rate currently sits in a range between 0% – 0.25%. Assuming the Fed follows the path it has in recent years, the Committee generally likes to raise the rate 25 basis points (0.25%) at a time, that means two or possibly three rate hikes depending on whether the federal funds rate ends up at the low end or high end of projections. Of course, all of this is dependent on the way things develop with the economy.
If you’re in the market for a mortgage, this matters because the federal funds rate is the rate at which banks borrow from each other overnight. Although not directly correlated, this rate tends to impact longer-term rates for things like mortgages.
That brings me to the actual press release from the Fed. One of the things the Committee mentioned is that it’ll be doing a faster pullback in the purchasing the Fed has been doing of mortgage-backed securities (MBS). The Fed has for some time been the biggest buyer of MBS.
The volume of the Fed’s buying has been such that mortgage rates were able to be lower because the yield on the underlying bond didn’t need to be as high in order to attract an investor. As the Fed slows down its purchases, yields more likely need to push higher to attract buyers. If that happens, mortgage rates would rise.
What does all this mean in practical terms? If you’re in the market for a mortgage right now, take action if you see rates you like. No one ever knows for sure how the market is going to move, but all the indicators are pointing up, so if you’re ready, apply now!
The press release is below. My analysis is in bold.
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The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.
This has been the same opening paragraph that’s been in every statement since COVID-19 found its way to U.S. shores. Basically, we’re still locked in a struggle and the Federal Reserve is going to do everything in its power to support the economy.
With progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months but continue to be affected by COVID-19. Job gains have been solid in recent months, and the unemployment rate has declined substantially. Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.
The most important thing in this paragraph might be what’s not in it. The word “transitory” has been cut. While most economic indicators have shown real improvement, there’s an acknowledgment that the inflation problem is real and needs to be dealt with. At the same time, the Federal Reserve says that financial conditions remain good for those looking to gain credit, whether that’s a household or business.
The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, including from new variants of the virus.
COVID-19 continues to be a controlling factor. The Fed is counting on two things: First, it hopes increased vaccinations make people comfortable doing the everyday things that keep the economy going. Second, it’s banking on the fact that as more supply becomes available, it has a dampening effect on inflation. However, much is dependent on what happens with the virus.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent. With inflation having exceeded 2 percent for some time, the Committee expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment. In light of inflation developments and the further improvement in the labor market, the Committee decided to reduce the monthly pace of its net asset purchases by $20 billion for Treasury securities and $10 billion for agency mortgage-backed securities. Beginning in January, the Committee will increase its holdings of Treasury securities by at least $40 billion per month and of agency mortgage‑backed securities by at least $20 billion per month. The Committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook. The Federal Reserve’s ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.
The decision paragraph is the longest paragraph in any Federal Reserve statement and there’s always a lot of information packed in, but that seems especially true for this month. Let’s break this down into about five paragraphs.
First, the Committee wants to have yearly inflation around 2% per year. Having a little bit of inflation encourages people to buy now rather than wait, which creates jobs and keeps further money flowing through the economy. Inflation is running higher than that right now and the Committee spends the rest of this section on how it’s going to combat the problem.
One of the levers the Federal Reserve has to control inflation is the federal funds rate. Right now, the rate is remaining at 0% – 0.25%. As we mentioned earlier, the projections for next year point to at least a couple of rate hikes minimum. This will make it more expensive for banks to get money and thus less easy for consumers to borrow as the increase gets passed on.
However, it makes banks treat the money they do have as if it’s worth more, so you might get some more interest on your savings account. This also has the effect of moderating inflation.
The Federal Reserve has also been purchasing a ton of treasuries and MBS with the goal of keeping interest rates down for mortgages, among other items. This keeps rates down, but it’s also contributed to home prices that are skyrocketing and contributing to higher inflation. The Committee is doubling the pace of the treasury and MBS buying reduction in an attempt to slow inflation.
There are really two takeaways here if you’re in the mortgage market: If you’re ready to purchase or refinance now, it might not be a good idea to wait around hoping for rates to drop again. Second, if you’re planning to buy a home at some point in the future, it’s not all bad. As sellers adjust to a higher rate environment, the pace of price increases will likely slow to give you some relief.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
The Committee reiterates that all of this is dependent on the direction the economy goes in the future and it’s prepared to make changes as necessary. COVID-19 continues to be top of mind, but the Committee will also be looking at the labor markets as well as price pressures, both real and expected. Finally, it’ll be looking at financial markets and worldwide conditions.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Raphael W. Bostic; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Mary C. Daly; Charles L. Evans; Randal K. Quarles; and Christopher J. Waller.
Everyone was in agreement.
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