March 2010: D-Day For Low Mortgage Rates?

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The Federal Reserve doesn’t “do” deadlines, preferring to shape policy much like the Colorado River shaped the Grand Canyon – gradually, but inexorably, over time.

But signals from the Fed indicate that patience is wearing thin at the economic policy board, with some economists maintaining that the Fed must take the training wheels off and give the economy a chance to grow on its own. A big part of that strategy is encouraging private investors to jump back into the mortgage market – with or without a net from Uncle Sam.

It’s the latter point we’re interested in today. Recently, the Federal Reserve announced it will cease its mortgage security buyback program next March – a program that helped keep interest rates artificially low for much of 2009. That should change the rate picture by Spring 2010, most likely bringing interest rates upward.

It takes some tea-leaf reading, but that seems to be the consensus, based on the Fed’s own actions, directives and language used in recent public policy statements. For example, here are the minutes from last week’s Federal Reserve meeting, where the policy-making committee decided to keep the benchmark Federal Funds rate between 0% and .25% – for now – but phase out the mortgage security purchase program by Spring 2010.

“To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.”

So there, in Federal Reserve-speak, you have it. The closest thing to a deadline you’re going to see – a March target to stop buying back mortgage-backed securities, which should trigger an almost immediate uptick in mortgage rates.

Here’s why. The end of the buyback program is only one of the weapons that the Fed can use to influence the economy. The others? Option #1 is usually an attempt to drain the excess reserves from the U.S. banking system. Option #3 is raising the Fed funds rate, a move that the Federal Reserve seems reluctant to do.

Right in the middle is the mortgage-backed security purchase program. That program represented $1.25 trillion of much-needed cash into the mortgage-backed security market.

To the average mortgage consumer, the program was a roaring success. With the Federal Reserve spending tens of billions of dollars monthly on mortgage securities that private investors likely wouldn’t have bought, interest rates were kept low, at between 5% and 5.25% for much of 2009.

But if the Fed follows through on its promise to close the program down, and lean on the private sector to pick up the slack, that could well leave a huge hole in the mortgage-backed securities marketplace. If the economy doesn’t cooperate, and sends private investors into the mortgage marketplace to plug the gap (a good bet right now), then look for interest rates to rise next March.

The Fed may not do deadlines, but it’s not above firing a warning shot to the American consumer. If you want to buy a home, do it in the next three or four months. After all, the difference in monthly mortgage payments of 5% or 6% can be measured in tens of thousands of dollars over the life of the loan.

So beware the Ides of March. After that, all bets are off.

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