Will the FED’s ‘Quantitative Easing Lower Rates . . . or Raise Them?!?!

You can’t turn on the news these days without hearing about the Federal Reserve Board’s attempt at keeping interest rates low to spur more lending (for mortgages, business lending and other consumer loans) via a plan known as Quantitative Easing part 2 (QE2).

The plan provides for the FED to purchase Treasury Bonds to take them out of the market. When the supply of Treasuries is reduced, the price will increase due to simple supply and demand. When the price of Treasuries increase, the Yield (or return) on those Treasuries decreases. The Yield is the cost of money to lenders so the lower the Yield, the lower rates will be.

Mortgage rates are based on the Yield of Mortgage Backed Securities, which are closely tied to the performance of Treasury bonds. So when Treasury prices increase, typically you will see the price of Mortgage Backed Securities increase as well. When these prices go up, the Yields go down and this is supposed to bring down mortgage rates.

Unfortunately, the immediate effect of this most recent Quantitative Easing has been the opposite. Because many investors had already expected QE2, they had priced the decreased supply of Treasuries into the market. When the announcement was made that the FED would be buying approximately $600Billion of Treasuries, the market was actually disappointed and this drove the price of Treasuries lower – in turn raising the Yield and Mortgage Backed Securities followed in kind. The market had anticipated a purchase closer to the $1 Trillion range.

In the short term, rates have increased a bit and the level of support for lower prices for Mortgage Backed Securities seems to be on the near horizon. This could certainly change so if you are in the market to buy or refinance a home, you will want to work with someone that monitors these changes on a daily basis as we are seeing swings in rates on a daily basis – and often with multiple changes in a single day.

I often equate the Mortgage Backed Securities market to someone buying a Certificate of Deposit (CD) at a bank. Right now, the rates are so low on CD’s that there really is a disincentive to purchase one and tie your money up for a prolonged period of time at such a low return. Imagine purchasing a 30 year Mortgage Backed Security and having to take such a low return for 30 years!

With returns so low for these investors, it may not be likely that they would be willing to accept any less moving forward. If this happens, no amount of Quantitative Easing will entice them to pay more for the Mortgage Backed Securities and therefore it would be unlikely that we will see any significant reduction in mortgage rates. No one can predict if rates will be headed any lower in the short term, however, one thing is certain and that is that rates will increase at some point.

The main hesitation for Mortgage Backed Security investors at this point is that they don’t want to be stuck holding these long term investments for a prolonged period of time with such a low return when rates increase. This is primarily what is keeping the rates from going lower as the FED had intended.

Let’s see what the next few weeks and months hold for mortgage rates. Either way, with rates at historic lows, it would pay to start investigating any buying or refinancing options at this time before they do go up.