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Why the Fed's Policy Statement Has More to do With Dropping Mortgage Rates



December 16, 2008 – Comments (0)

As many of you already know, mortgage rates are not dependent upon what the Fed does with their rate cut decision.  rather, they are derived from mortgage backed securities, aka mortgage bonds or MBS.  Typically, when the Fed cuts their rate, mortgage rates actually move in the opposite direction.

Today was not a typical day as the Fed cut rates dramatically, but mortgage rates also dropped.  So just what happened?

The answer lies in the Fed's Policy Statement, not in the actual decision.  The reason mortgage rates dropped was due to the rally in mortgage backed securities that occurred as a direct result of what the Feds had to say, not their actions.  Let's take a closer look at what they said...

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.  Financial markets remain quite strained and credit conditions tight.  Overall, the outlook for economic activity has weakened further. (weaker economic activity is favorable to lower mortgage rates and recent economic data supports this statement.)

Meanwhile, inflationary pressures have diminished appreciably.  In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters. (inflationary pressures have only diminished in terms of what we see in PPI and CPI.  Real inflation, however, is likely on the rise due to the incessant printing of money, not to mention what will occur if the Fed gets their way and opens the credit lines full again. The dollar is already showing signs of its true weakness.)

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.  In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. (This is scary as all they have done to save the markets has only done what historically has been accurate, merely prolonged the crisis.  For one who is known for his works on the Great Depression, Bernanke surprises me in his actions that he should know won't stave off the inevitable.)

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. (and there you have the gem for mortgage rates, the Federal Reserve's promise to keep buying mortgage backed securities in large quantities with "fake" money, even if no one else is willing to buy them.  On top of that, they want to extend their hand beyond their own reach and take over all lending, likely even credit and debit cards.  Very scary indeed.)

The reaction in the mortgage bond pits was essentially due to the statements the Fed made regarding continued purchasing of mortgage backed securities, and supported by a weak economy and the mere expectations of inflation continuing to moderate, whether true or not.

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