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FOMC Minutes Confirm That “Tapering” Is Closer Than Expected

- Christophe Barraud


Last night, the FOMC published Minutes from October meeting. Even they did not provide specific insight into the timing of an initial tapering move, they suggested that (1) “tapering” will start in coming months even before an unambiguous further improvement in the outlook was apparent”, (2) Fed members considers equal cuts to MBS and Treasury Purchases, (3) Fed has yet to determine the best way to help further distinguish between tapering and tightening.


We could isolate some excerpts from the FOMC Minutes:


Participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent. A couple of participants thought it premature to focus on this latter eventuality, observing that the purchase program had been effective and that more time was needed to assess the outlook for the labor market and inflation; moreover, international comparisons suggested that the Federal Reserve’s balance sheet retained ample capacity relative to the scale of the U.S. economy.

A number of participants believed that making roughly equal adjustments to purchases of Treasury securities and MBS would be appropriate and relatively straightforward to communicate to the public. However, some others indicated that they could back trimming the pace of Treasury purchases more rapidly than those of MBS, perhaps to signal an intention to support mortgage markets, and one participant thought that trimming MBS first would reduce the potential for distortions in credit allocation.


Participants discussed the financial market response to the Committee’s decisions at its June and September meetings and, more generally, the complexities associated with communications about the Committee’s current policy tools. A number of participants noted that recent movements in interest rates and other indicators suggested that financial markets viewed the Committee’s tools–asset purchases and forward guidance regarding the federal funds rate–as closely linked. One possible explanation for this view was an inference on the part of investors that a change in asset purchases reflected a change in the Committee’s outlook for the economy, which would be associated with adjustments in both the purchase program and the expected path of policy rates; another was a perspective that a change in asset purchases would be read as providing information about the willingness of the Committee to pursue its economic objectives with both tools.


Since the last FOMC meeting, several figures have showed that growth will be stronger than expected in H2 2013. Moreover, PCE inflation rebounded in Q3 and the October employment report was very strong. As a consequence, if the incoming data confirm the recent improvement and the Congressional budget committee finds a comprise concerning fiscal issues by Dec. 13, the Fed could decide to taper before the end of the year which is sooner than expected (March 2013).


Regarding the constitution of asset purchases, I think that people were surprised to read that the Fed could reduce both its Treasuries and MBS’ purchases in the same time. The fact is that MBS market is less liquid and impacts directly mortgage rates.

US Mortgage Rates Reached 12-Month Highs

Recently, some concerns appeared regarding the level of mortgage rates. Yesterday, Zillow recorded that this week, mortgage rates for 30-year fixed mortgages rose to 3.71% (up from 3.58% at this same time last week) and reached a 12-month highs. This movement occurred after ten-year Treasury bond rebounded above 2% amid speculation that the Federal Reserve could pull back on its bond-buying program before than expected. This idea was backed by Erin Lantz, director of Zillow Mortgage Marketplace:


“Rates spiked last week after meeting minutes revealed the Fed was contemplating scaling back economic stimulus plans much earlier than expected”


Remind that US central bank is buying $40B of MBS and $45B of Treasuries every month in an effort to reduce borrowing rates and that there is a strong correlation between the mortgage market and the US Treasury bond market. Indeed, holders of mortgage securities used to hedge the risk of declining MBS prices by selling US Treasuries.


Zillow data were confirmed by numbers which show a rebound in May of 30-fixed-mortgage-rates (almost 50 bp to 3.88%).



FT noted this sharp rise is also the result of a sell-off in the market for mortgage-backed securities as real estate investment trusts and portfolio managers had been active sellers. The article underlined that:


“MBS prices have tumbled to levels not seen in more than a year, and well below the level when the Fed began its latest round of purchases last September.”… “Further sharp falls on Tuesday sent the price of some recently issued MBS, which pay a coupon of 3 per cent, below a price of 101 of face value, down from a peak this year of nearly 105 in early May. The slide in price has eroded capital gains for investors, and added fuel to the sell-off. The most popular tranche of MBS, securities which pay a coupon of 3.5 per cent, have tumbled from a peak of almost 107 to below 104.”


Even if my view is that 10-year Treasury bond will not hit 2.40% before at least the end of the year (mainly because of moderate growth and low inflationary pressures) and will not push mortgage rates much higher, this move will affect immediately refinancing activity and then purchasing activity. Note that refinancing activity is already under pressure as Mike Fratantoni, MBA’s Vice President of Research and Economics said today:


“Refinance applications fell for the third straight week bringing the refinance index to its lowest level since December 2012 as mortgage rates increased to their highest level in a year”