The FED, MBS’s, and the pending effects on Interest Rates
At the end of March the Federal Reserve is slated to end it’s purchase program of mortgage backed securities (MBS). The program was initially undertaken to provide a sense of stability for the US residential real estate market by preventing interest rates from drastically moving higher during the recession.
Here, for all intents and purposes, we can define a MBS as a simple bond. Like all bonds when the price increases, the interest rate (yield) decreases and vice versa. During the last year and a half investors have become hesitant to own risky, illiquid, and difficult to value securities. Hence, the FED program artificially inflated the prices of MBS’s with their purchases, keeping interest rates low.
Check out the article below for more on this topic:
http://realtytimes.com/newsfiles/realtimes2.nsf/rtpages5.1/20100309_rates.htm
As the economy recovers and investors’ aversion to risk begins to subside, there will certainly be demand for MBS purchases. The point left for debate is whether or not that demand will be enough to offset the end of FED purchase program. It is very unlikely that interest rates will move down from their current levels. The end of the MBS purchase program will provide some clarity as to where true interest rates should be. A moderate and gradual increase in rates should provide added stability to a slowly healing market, assuming it does not cut off the consumers’ purchasing power at the knees. The FED is prepared to re-initiate the program if need be. As it stands now…many questions, few concrete answers.
Best,
JLC
