Wednesday, February 17, 2010

Interest Rates

Rates remain very attractive, but for how long?

"IT AIN'T OVER TIL IT'S OVER." Yogi Berra. And whether you find those words deeply wise or simply puzzling...The Fed has told us repeatedly that their massive purchasing program of Mortgage Backed Securities is just about over - and this translates to home loan rates rising in the near future.

As you can see in the chart below, the amounts of Mortgage Backed Securities the Fed is purchasing are slowly dwindling, as the program is set to wrap up by March 31st, and are clearly trying to ration out the remaining portion. Last week, the Fed purchased $11 Billion in Mortgage Backed Securities, which leaves them with $66 Billion to spend out of their original $1.25 Trillion allotment. So about 95% of the total has already been spent and has purchased about 3 out of every 4 home loans during the past year. When such a large buyer leaves the market, it is very likely that prices will worsen.

This is very important because as the Fed has less money to last through the remaining months of the program, their ability to keep home loan rates low via their purchasing power will wane. And those who can take advantage of currently low home loan rates do not wait, as the clock on these historically low rates is ticking.

Also last week, Fed Chairman Ben Bernanke provided a speech on a number of topics, perhaps the most important of these being switching the Fed's benchmark from the commonly watched and monitored Fed Funds Rate, to a new benchmark of "interest paid on excess reserves". Banks are required to keep money on reserve with the Fed and may, from time to time, have an excess in those reserves, which the Fed can pay interest on. Since the Fed Funds Rate is only a "target rate", banks can still lend money to other bank overnight at their own negotiated rate. Sometimes near the end of the trading day, banks have been lending their excess reserves out overnight for a rate that differs from the Fed Funds Rate, but is higher than interest on those reserves from The Fed. This undermines the Fed's ability to set a reliable benchmark.

The Fed wants to fix this by using the amount of interest they pay as the new benchmark, since the Fed has total control of this rate, which should be right at or just under the Fed Funds Rate.

There is one major take-away from this discussion - it appears that the Fed is getting their ducks in a row as they prepare to push interest rates higher. And when they do increase rates, the Fed does not want any obstacles that may undermine their plan.
Post a Comment