Mortgage rates are trending higher again as bond market investors weigh the Fed’s next move

After trending down from their peak in the first week of May, mortgage rates are trending higher this week as bond market investors weigh the Federal Reserve’s likely next steps to fight inflation.

Ahead of a meeting on Tuesday with Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell, President Biden said his top priority is fighting inflation and that he “respects the independence of the Fed” and will “not interfere with its vitally important work.” ”

The Fed has made it clear that not only will it continue to raise the overnight interest rate this year, but this month it will start trimming its balance sheet of nearly $9 trillion, including $2.7 trillion in mortgage-backed securities that the Fed bought as part of its “quantitative easing” program to keep mortgage rates low during the 2007-09 pandemic and recession.

The Optimal Blue Mortgage Market Indices (OBMMI) show that interest rates on 30-year fixed-rate mortgages — which had been falling steadily since hitting a 2022 peak of 5.593 percent on May 6 — are recovering after the Memorial Day holiday weekend and up 7 basis points Friday through Tuesday to 5.344 percent.

A basis point is one hundredth of a percentage point. Mortgage rates on Tuesday were still 25 basis points, or a quarter of a point, below their high for the year.

Mortgage rates are recovering

That trend is likely to continue as yields on 10-year Treasury bills – a useful barometer of developments in mortgage rates – rose 10 basis points on Wednesday lunchtime.

As the Fed tries to start “quantitative tightening” — offloading some of the debt off its balance sheet — it could lead to more interest rate volatility and upward pressure on rates, Reuters reports.

The Fed’s $9 trillion balance sheet

The assets the Federal Reserve holds through quantitative easing purchases now include $5.77 trillion in long-term Treasuries and $2.7 trillion in mortgage-backed securities. Source: Federal Reserve System Board of Governors, Federal Reserve Bank of St. Louis.

For much of the pandemic, the Fed cut long-term interest rates to historic lows, increasing its Treasury holdings by $80 billion a month and expanding its mortgage-backed securities portfolio by $40 billion a month. Although the Fed has stopped adding to its debt stocks, it maintains them by replacing assets as they mature – and remains a factor supporting demand for bonds and helping to keep interest rates in check.

The Fed is curbing purchases of mortgage-backed securities

Source: Monthly Chartbook published by the Urban Institute Housing Finance Policy Center, “Housing Finance at a Glance,” May 2022.

Just to replace its maturing assets in April, the Fed had to purchase $35.4 billion worth of mortgage-backed securities — more than a fifth of the mortgage-backed securities sold by Fannie Mae, Freddie Mac and Ginnie Mae that month were spent, according to the Urban Institute Center for Housing Finance Policy.

As the Fed begins “quantitative tightening” – rolling that debt off its balance sheet – interest rates could come under more pressure.

Beginning June 1, the Fed will begin reducing its mortgage investments by no more than $17.5 billion per month by rolling maturing assets off its books. The plan calls for the pace of tightening to increase to $35 billion per month over three months. Treasury rolloff caps will be higher – initially $30 billion per month, rising to $60 billion per month after three months.

Without the demand created by the Fed’s purchases of Treasuries and mortgage-backed securities, there is concern that supply will exceed investor demand. When there is more supply than demand, it pushes bond prices down and yields up.

“The risk is that the market can’t absorb the additional supply and you have a big adjustment in valuations,” TD Securities rates strategist Gennadiy Goldberg told Reuters. “We’re still going to see more long-term supply than we did pre-COVID for quite a while, so other things being equal print rates should be a bit higher and the [yield] curve a little steeper.”

The good news is that homeowners are less keen on refinancing their existing mortgages as mortgage rates have already risen more than 2 percentage points this year – meaning the Fed could have a hard time hitting its targets for the to reduce their mortgage debt.

At a news conference last month, where Powell outlined its quantitative tightening targets, he said it might not even be able to meet the initial $17.5 billion cap on rolloffs of its mortgage-backed securities.

“At the current level of mortgage rates, the actual rate of outflow from agency MBS would likely be less than this monthly cap,” Powell said.

Demand for mortgages at lowest level since December 2018

Meanwhile, demand for purchase credit fell slightly last week even as mortgage rates fell for the fourth time in five weeks, with first-time homebuyers facing the biggest challenge from this year’s rise in mortgage rates.

After adjusting for seasonal factors, applications for purchase mortgages fell 1 percent last week compared to the previous week, according to the Mortgage Bankers Association’s weekly survey of mortgage applications.

Joel Kan

Purchase loan applications were down 14 percent year-over-year, but “with more activity at the larger loan sizes,” MBA forecaster Joel Kan said in a statement. “Demand is high at the top end of the market, and the supply and affordability challenges are not as detrimental to these borrowers as they are to first-time buyers.”

While the average request for a traditional purchase loan was $460,800, the average request for FHA loans, popular with first-time buyers, was $258,100.

When demand for purchase credit is weaker, refinancing requests have fallen even more dramatically, down 5 percent week-over-week and 75 percent year-on-year, the survey found.

Aggregate demand for mortgages, both for purchase and for refinance, has fallen to its lowest level since December 2018 “as the procurement market continues to grapple with supply and affordability issues,” Kan said.

For the week ended May 27, the MBA reported average interest rates on the following types of loans:

  • Fixed rate for 30 years compliant mortgages (loan balances of $647,200 or less), rates averaged 5.33 percent, up from 5.46 percent the week before. With the points falling from 0.60 to 0.51 (including origination fee) for loans with an 80 percent loan-to-value ratio (LTV), the effective interest rate also fell.
  • Prices for 30 years of fixed interest jumbo mortgages (loan balances over $647,200) averaged 4.93 percent, up from 5.02 percent the week before. Although the points for 80 percent LTV loans remained flat at 0.41 (including the origination fee), the effective interest rate also fell.
  • Fixed rate for 30 years FHA mortgages, interest rates averaged 5.20 percent, up from 5.36 percent the week before. The effective interest rate also fell, with points falling from 0.82 (including origination fee) to 0.69 for 80% LTV loans.
  • prices for 15-year fixed-rate mortgages an average of 4.59 percent versus 4.72 percent the week before. With points falling from 0.70 to 0.63 (including origination fee) for 80% LTV loans, the effective interest rate fell.
  • To the 5/1 variable rate mortgages (ARMs) yields averaged 4.46 percent, up from 4.49 percent the week before. The effective interest rate also fell, with points falling from 0.76 (including the origination fee) to 0.68 for 80% LTV loans.

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