The Fed's Exit Strategy: Will it Work?


Beware the Ides of March — especially if you’re a mortgage loan shopper who doesn’t want to see rates drive upward. But that might be the case, as the Federal Reserve pulls out of the mortgage-backed securities market.

The Fed has spent upward of $1.25 trillion to buy up mortgage-backed securities from banks and other mortgage lenders since September 2008. That campaign helped boost the price of mortgage securities, which in turn pulled down mortgage rates.

With mortgage rates low, millions of homebuyers and homeowners got cheaper loans, helping keep prices stable in a period of great economic volatility. At the apex of the Fed buyback spree, mortgage rates fell to 4.71% in late 2009, as measured by the Weekly Mortgage Rate Tracker. According to loan giant Freddie Mac (Stock Quote: FRE), that’s the lowest recorded mortgage rate ever documented by the agency.

But if those prove to be the salad days, then lower rates are almost certainly off the menu when the Fed pulls its grand "exit strategy" in March. How will that impact the market at large? Most likely, it will rock the economy just as some signs were emerging that it was getting back on its feet. Here are a few reasons why:

Housing Hit: Contractors, homebuilders and real estate professionals will see a slowdown in activity, as higher rates will lead to fewer home sales and fewer new homes under construction.

Unemployment: The U.S. Census is expected to add 800,000 new jobs, albeit temporary ones, to the U.S. economy. But if there is a big hit to the housing and real estate sectors because of the Fed’s exit policy, expect those gains to be neutralized by layoffs in impacted sectors.

Investor Risk: According the U.S. Treasury Department, which released the minutes of its recent Treasury Borrowing Advisory Committee meeting, one committee member reported that “near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield. A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero.”

The Fed’s mortgage-backed security program’s exit strategy is set to commence on March 10, unless the powers-that-be change their minds (an unlikely scenario according to economists).

When that happens, the risk is heightened of a ripple effect that could stall any economic recovery, and leave the housing industry spinning out of control again.

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