Fed rate hike: To be or not to be during banking crisis ?
With unfolding of a major banking crisis, how will Fed act on benchmark rates without triggering further stress in the system ?
In this week’s newsletter, we will explore what lies ahead for benchmark lending rates and where are housing prices headed in the coming months.
What’s inside:
With Silicon Valley Bank crisis, the 10 year treasury yield slipped under 3.57% bringing down mortgage rates to 6.57%.
Will the rates stay there or possibly go down further ?Will Fed increase the benchmark rates at the current pace?
What do market experts think ?If the rate hike uncertainty continues, what effect will it have on mortgage rates?
Here’s a complete low-down 👇
Before you move on …
We would love, if you could subscribe to our newsletter.
In our last weekly newsletter, we saw that mortgage rates were going up - mainly due to sticky consumer demand & strong wages despite a housing inventory shortage. This has been feeding into record high inflation - something that’s top-most priority on Fed’s agenda in the current financial year.
However, last week’s bank run on Silicon Valley Bank proved to be a curve ball.
Mortgage rates took a nose dive early last week as the fall of Silicon Valley Bank triggered fears of contagion spreading through the banking system.
The average rate on a 30-year fixed mortgage dropped to 6.57%, according to Mortgage News Daily, down from 6.76% on Monday and a high of 7.05% on Wednesday from two weeks ago.
Mortgage rates closely track the the yield on 10-year Treasury bonds, which fell on Monday to the lowest level since early February. Over the last few weeks, treasury bond yield was hovering in the neighborhood of 3.94%. Correspondingly, mortgage rates tracked close to 7%.
With the government stepping in to bail out Silicon Valley Bank depositors, the 10 year treasury yield slipped under 3.7% - dipping the mortgage rates to 6.57%.
With affordability at the lowest point in decades due to tight housing inventory - lower mortgage rates, could provide some relief for potential homebuyers.
But the big question - will Fed continue with its rate hike or take a pause to avoid risking a domino effect in an already stressed market ?
Possibility of 25 basis point hike ?
It’s anybody’s guess how exactly the Fed will respond.
Earlier, analysts were anticipating a half-point hike in the benchmark interest rate from its current 4.5% - 4.75% range during the FOMC’s (March 21-22) meeting - with further rate hikes in months ahead.
However, with the turbulence at Credit Suisse, analysts feel there is a possiblity where Fed might go slow. Traders now see next week as a tossup between a smaller quarter-point hike and a pause.
"I think they could indeed hike 25 bps next week. They need to keep up the fight on inflation to maintain credibility, and a pause here at these levels - isn’t going to stop the bleeding in the markets."
- Jefferies' Thomas Simmons.
According to Thomas, a pause at this point could obliterate all gains made thus far from the 4.5 percentage points of rate hike since last March.
It is worthwhile to note that while the recent bank failures could have some impact on Fed’s approach, they are not the only deciding factors.
The upcoming Consumer Price Index report on Tuesday will have a significant influence on Fed’s rate hike decision. As a matter of fact, another barometer of inflation - Personal Consumption Expenditures Price Index came out higher than anticipated.
This gives a cue as to the direction in which Fed is likely to move once the stress in the banking system is reasonably contained.
"It seems that recent developments have shifted the likelihood to either no rate hike or a smaller 25 basis point rate hike at next week's FOMC meeting.
Nevertheless, given the Fed chair's fear of losing the fight against inflation means that the policymakers will continue to rely heavily on recent data points, particularly the robust job growth, and will continue to look for data points that validate the need for more aggressive action."- Selma Happ, chief economist at CoreLogic
So how will this uncertainty impact mortgage markets going forward.
To be or not to be: That is the question
If Fed decides to go soft on rate hike, then mortgage rates may remain in the 6.5% range despite an expected fall in the 10 year treasury yields. This is counter-intuitive to what we stated earlier in this essay - that mortgage rates track closely to treasure yield.
This could happen because of the widening spread between the two benchmarks.
MBA was forecasting that the spread between 10 year US treasury yield and 30 year FRM rates would narrow from the current 280 - 300 basis points to 180 basis points.
However, due to the recent bank failures the spread will stay wider for bit longer.
Even though 10-year Treasury have come down, mortgage rates may not come down as quickly as they did in January.
- Michael Fratantoni, Chief Economist, MBA
Another fall out of this disconnect between treasury yield and mortgage rates is the inversion between conforming 30-year FRMs and their jumbo counterparts. For much of 2022, jumbo rates have been 50 basis points lower than conforming loans as banks try to increase the attractiveness of non-conforming products.
However, with greater uncertainty & regulatory oversight in coming days, banks are willing to push conforming products over non-QM.
In a nutshell, there’s a lot at stake for the mortgage & banking industry - depending on which direction Fed swings the benchmark rates.
With FOMC meeting round the corner, the stage is set, the actors are in place.
It’s time the curtains be raised on the play -
Fed rate hike: To be or not to be, that is the question