Fed may keep buying mortgage bonds to curb interest rates for home loans

US economic-policy makers are in no rush to stop buying mortgage bonds, as purchases help keep a lid on interest rates for home loans

PUBLISHED : Wednesday, 17 July, 2013, 12:00am
UPDATED : Wednesday, 17 July, 2013, 4:09am

When Federal Reserve policymakers start to curb US$85 billion in monthly bond buying, possibly before the end of the year, the last thing they want to do is spoil the nascent United States housing recovery.

That means the Fed may concentrate first on trimming purchases of Treasuries, while continuing to buy mortgage bonds to keep a lid on interest rates for home loans.

"There is a valid case to slow Treasury purchases before MBS [mortgage-backed securities] purchases," said Roberto Perli, a partner at Cornerstone Macro in Washington and a former economist for the Fed's division of monetary affairs.

"The recent sharp increase in mortgage rates poses a threat to the housing recovery, and a continued housing recovery is necessary if the economy is to stay on a more robust trajectory," he said.

US policymakers led by Fed chairman Ben Bernanke have said in the last two months that the central bank's mortgage-backed securities programme has helped the economy, with Boston Fed president Eric Rosengren urging reduction first in Treasury buying, and San Francisco Fed's John Williams saying mortgage buying was "more powerful".

Minutes of the Federal Open Market Committee's (FOMC) June meeting, released last week, showed about half of the 19 participants wanted to halt bond purchases by year-end. At the same time, the minutes showed many Fed officials wanted to see more signs that employment is improving before backing a slowing in the pace of the purchases, known as quantitative easing.

Bernanke said in a speech hours later that the US economy needed "highly accommodative monetary policy for the foreseeable future".

The European Central Bank provided guidance similar to the Fed's last week, saying its commitment to keep interest rates low for an extended period of time uses a "flexible horizon" and would depend on the euro area's economic performance.

The latest reading on the US labour market showed the number of Americans filing for unemployment benefits unexpectedly increased by 16,000 to a two-month high of 360,000 during a period when applications fluctuate because of plant shutdowns by carmakers, and the Independence Day holiday.

The FOMC said that it would continue buying US$40 billion in mortgage bonds and US$45 billion in Treasuries each month until the labour market "improves substantially". The committee also pledged to keep the main interest rate near zero so long as the unemployment rate remains above 6.5 per cent and the forecast for inflation doesn't exceed 2.5 per cent over one to two years.

Most participants in the June meeting expect that the Fed "would not sell agency mortgage-backed securities" that it already holds as it scales back quantitative easing, according to the minutes. The minutes didn't reflect any discussion on whether tapering of asset purchases would concentrate first on either Treasuries or mortgage bonds.

"The recovery in home prices has all sorts of beneficial effects," including "making you feel wealthier", Williams said. "Many people have responded to their improved finances by spending more on a range of goods and services."

The importance of housing to the recovery may shape the initial tapering, said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore who worked at the Fed's division of monetary affairs from 2004 until 2008.

"The centre of the committee would probably like to taper Treasuries first, but it is a committee that likes to try to achieve consensus," he said. "The motivation would be not to snuff out the rebound in housing. My guess would be they taper both but maybe a bit more on the Treasuries."

Brad Hunter, a Florida-based chief economist for housing research firm Metrostudy, said that at first, higher mortgage rates "stimulate demand, because some buyers who are currently hesitating or procrastinating will feel that they had better buy now".

As rates rise further, people may buy "either a smaller home or a home in a more remote location" and builders' price increases could be limited, he said.

Single-family housing starts were likely to rise 18 per cent to a 632,000 pace this year from a year earlier, and by another 26 per cent to 796,000 next year, he said.