Mortgage Rates Headed Higher After The Fed's Exit

It's the end of March, and if you've been paying attention, you know that today is when The Fed said it would stop buying mortgage-backed securities, in order to keep the machinery of mortgage finance moving. We've had plenty of warning, but the expected effects are worth repeating.

Background: for years banks and brokers that originate mortgages have sold them to companies (or government agencies) that package them and sell them on to banks, mutual funds and other investors. The originating banks and brokers can then lend their capital again (as we now know all too well), with the result of lowering the costs of mortgage finance to the consumer.

During the credit crisis, the mortgage-backed securities market froze up with everything else, and to get mortgage finance flowing, the Fed stepped in and purchased over $1 trillion of these mortgage bonds. Today's the last day, and tomorrow the system is once again on its own. (The Fed is not going to start selling the bonds it has already bought, it just won't be buying any more.)

Many smart people have weighed in on the effects, and Bill Gross of bond titan PIMCO, perhaps the smartest of all, says that without the Fed buying in large quantities, mortgage rates will probably have to go up to get the private buyers to take all the bonds. How much? Between one-half and one percent, added to today's record-low rates of about five percent.

At BlackRock, another bond titan, chief investment officer Curtis Arledge says the rise will be more like 15 or 20 basis points (that is, 0.15 to 0.20 percent), because the Fed has prepared the market for the change, but that rates might be more volatile. He provides a great explanation on video, thanks to Bloomberg.

Daniel Indiviglio at The Atlantic is weighing in on this question too, concluding that unfortunately, rates will stay low, Fed or no Fed:

Wall Street's seemingly relaxed attitude about the economy continues to surprise me, though I worry it's driven more by naïve optimism than realism...

...[A]fter April, demand for new mortgages could be very, very low -- even lower than it was in February. So a whole lot of investor demand might not be necessary to support the market. This also suggests that rates could remain low, if even a weak investor appetite can outweigh the supply of new mortgage originations packaged into securities.