May 9, 2022

Last week the Federal Reserve, through the Federal Open Market Committee, or FOMC, increased the targeted Fed Fund Rate by .50%, the largest rate increase in 22 years. Orion believes that it is important for our brokers to understand how the Fed’s move to dampens inflation and be able to explain it to clients. In addition to that, the Fed will also begin shrinking its enormous $9 trillion balance sheet of Treasuries and mortgage-backed securities (MBS).


This hike in Fed Funds Rate has no direct effect on home loan rates. Oddly enough,the measures the Fed is taking to lower inflation help preserve the value of long-term fixed-income securities like MBS. If the Fed is successful in bringing down inflation, it will help long-term bond prices improve and long-term rates remain relatively stable.


But the increase in the Fed Funds Rate will immediately impact all short-term loans, like auto loans, credit card debt, and home equity lines of credit. Increasing these rates is expected to slow consumer demand, which in effect will slow price increases. Put another way, if you raise rates, people and companies will cut back on buying things, or building factories.


Fed Chair Powell gave the market comfort when he said there was "a good chance to have a soft landing,” meaning the Fed can continue to raise rates more and slow demand without pushing the economy into a recession.


How much more will the Fed hike rates? The Fed Chair signaled they are likely to raise rates by another .50% in both June and July. Of course, making these moves will depend on the incoming data. This means we should continue to expect high-interest rate volatility around key economic reports like inflation, GDP, and the labor market. Despite the Fed Chair saying the Fed is not considering a.75% rate hike, the markets finished the week assigning a very high probability the Fed will hike by .75% in June.


Of particular interest to brokers is the news that the Federal Reserve will also be reducing its balance sheet. "Beginning on June 1, principal payments from securities held in the System Open Market Account will be reinvested tothe extent that they exceed monthly caps." The balance sheet reduction announcement means the Fed will be buying fewer bonds going forward. This “Quantitative Tightening” is the opposite of what the Fed did through “Quantitative Easing”where it purchased $5-8 billion a day, or $120 billion a month, worth of Treasuries and MBS.


Home loan rates are at an important juncture. They shot up in March and April, and now have stabilized. But there is a real threat they can go another leg higher and fast. Or not. No one has an interest rate crystal ball, but suffice it tosay that Orion’s brokers should know that the Fed is set on raising short-termrates, and the same factors that influence its moves also influence mortgage rates.

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