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Everyone has heard about the Federal Reserve’s decision to scale back bond purchases. The “tapering,” to use Wall Street parlance, was based on the improving economy, including the labor market. Nonetheless, potential homeowners should not be overly concerned about the impact on mortgage rates.
To a large extent, the bond market had already been pricing in this improved economic picture. Ten-year Treasury rates rose from under 2% to about 2.85% right before the Fed’s announcement. Subsequently, ten-year rates increased slightly to 2.94%. In the week prior to the decision, thirty-year mortgage rates rose to 4.47% from 4.42%, according to Freddie Mac. On the Bankrate website, it currently shows an average rate of 4.49%.
There is a strong relationship between risk-free Treasury rates and long-term fixed mortgage rates. Fixed rate mortgages will increase the higher Treasury yield climb. Adjustable rate mortgages are based on short-term rates, such as the Fed Funds rate, which is directly controlled by the Federal Reserve via open market purchases.
To be clear, most of the extraordinary measures the Federal Reserve undertook during the recession remain in place. Its monthly purchases of mortgage-backed securities and longer-term Treasuries will be at $35 billion and $40 billion, respectively, each scaled back a modest $5 billion per month. Short-term interest rates will continue to be at near zero percent.
The Federal Reserve cited economic activity expanding at a “moderate” pace. Although labor conditions have improved, the unemployment rate remains “elevated.” This demonstrates the Federal Reserve remains concerned about the pace of the recovery, and is in no hurry to see long-term interest rates rise significantly.
Those seeking a home should also note mortgage rates remain attractive, particularly by historical standards. Thirty-year rates dipped below 3.5% last year, but was over 6% in the years leading up to the recession, according to data provided by Freddie Mac. At the start of the decade, it hovered around 8%, and in the late-1980s, it was in double-digits even after the hyper inflation from earlier in the decade had been tamed.
To summarize, do not get scared by the latest headlines. Longer-term rates are increasing because the economy is improving, not because of higher inflation. This is positive, even if it means mortgage rates have risen from rock-bottom levels. Nonetheless, the Fed is taking a deliberate approach to long-term rates. This reflects the market’s very modest reaction. Those seeking a home can be comforted by the attractive long-term mortgage rates. Although not likely to spike, rates will not remain at these levels forever. As the economy continues its gradual improvement, homebuyers will likely look back in a few years with a smile based on their mortgage rate.