In a move that can only be described as “out of left field,” the Federal Reserve’s Open Markets Committee (or FOMC) released a post-meeting statement yesterday indicating that it would keep the target fed-funds rate around 0.00% – 0.25% through the end of 2014 in order to keep the economy growing. This is an absolutely unprecedented statement, as it looks forward three years. As you might expect, both U.S. Treasury and mortgage-backed securities (MBS) rallied hard, and we ended up closing up about 50bps on the day in the MBS market. Prior to the announcement, the Fed had indicated that rates would remain low through the middle of 2013.
WHY THIS? WHY NOW?
The Fed has indicated that there are “significant downside risks” to the U.S. economy in the months ahead, specifically in the areas of unemployment and (no surprise to any of you) housing. Additionally, Europe remains the 800-pound gorilla in the room, with all eyes on Greece as it yet again tries to negotiate concessions from its creditors to avoid a “hard default.” As I’ve been saying for almost a year now, it is a virtual certainty that Greece will experience some sort of default – whether soft (lenders voluntarily accepting a “haircut” in Greek debt) or hard (a refusal to make interest payments). In fact, it looks now like that default may come as early as March. If it is a hard default, that will trigger payments to investors under insurance contracts (known as “credit default swaps” or “CDS”). Couple the payments that will have to be made on the CDS by the policy issuers (largely banks) with the losses incurred by institutional investors (also banks) not receiving interest payments on the defaulted debt, and we have a high likelihood of the entire European banking system being thrown into crisis and the world – including the United States – being thrown back into recession.
Even if Greece manages to renegotiate its debt again this time, eventually the austerity measures may lead its citizens to vote out the current government and replace it with one that will default on the debt, take the country off the euro and end up back on the drachma (which carries with it a whole different set of pain points, but that’s beyond the scope of this post). Should the world manage to weather the storm that is Greece, the specter of Spain’s problems (and Portugal’s and Italy’s too) looms on the horizon. In other words, the headwinds are great and the Fed recognizes that.
Interestingly, much is being made of this morning’s positive economic news that durable goods orders jumped much higher than expected last month. This is the latest in a string of reports that may lead some to conclude that we’re almost to the “happy days are here again” point. Unfortunately, new home sales dropped again, making 2011 the worst year on record, AND the index of leading economic indicators (indicators of future economic activity), although improved, fell significantly short of expectations. I still remain cautiously optimistic (economically) in the short term, but the leading economic indicators are a key piece of the puzzle to keep focused on in the upcoming months. If today’s reading wasn’t just a “blip” and we see a downward trend, that will indicate that the U.S. economy is beginning to slow.
I’m sure that many of the originators reading this post are excited about the drop in rates that they saw on rate sheets over the past 36 hours – as well they should be! However, I would strongly advocate that you use caution when advising borrowers regarding rate locks. It’s only natural that borrowers hear the news about the Fed and think that mortgage rates are going to plunge; most borrowers don’t realize that the Fed does not control mortgage rates. I am of the opinion that we won’t see much further of a decline in mortgage rates UNLESS Greece (or Spain) starts the default chain-reaction across the Atlantic. Then all bets are off.
Although I do believe that default will come – at least to Greece – it is impossible to say when it will occur. While floating shouldn’t hurt borrowers in the short term because there’s not really much that would lead to a spike in rates at the current time, don’t advise a borrower to float and postpone closing, waiting for that extra 1/4 of a point in rate. It simply doesn’t make sense from my perspective; why sacrifice an unprecedented low rate and postpone real-dollar savings in the hope that you just might – maybe – see a 1/4 better over the next few weeks or months? Remember the old Wall Street adage: “bulls make money, bears make money, pigs get slaughtered.”
Now, let’s go find a client and sell a home or a loan!