Home-Loan Drop Pushes Fed Away From Mortgage Bond TaperJeff Kearns
Federal Reserve policy makers, while considering today whether to taper $85 billion in monthly bond buying, confront a drop in demand for home loans that argues against a cut to their mortgage bond purchases.
A surge in mortgage rates to two-year highs has undercut borrowing, pushing down refinancing by more than 70 percent since last September. Wells Fargo & Co. said this month originations may fall 29 percent this quarter, while JPMorgan Chase & Co. said volumes may plunge 40 percent in the second half compared with the first six months of the year.
The Fed today would limit the impact from tapering by reducing Treasury purchases rather than mortgage-backed securities, said Michael Gapen, a senior U.S. economist at Barclays Plc in New York. Buying mortgage bonds reduces home loan rates, increases house prices, and pushes up consumer confidence and spending, said Gapen, a former researcher in the Fed’s Division of Monetary Affairs.
“There’s a fair degree of consensus that MBS purchases are more effective than Treasuries in terms of stimulating activity,” said Gapen, who expects the Fed to reduce monthly purchases by $10 billion in Treasuries and $5 billion in mortgage bonds. “It’s a more direct route to housing and household balance sheets.”
The Federal Open Market Committee today will probably conclude a two-day meeting by dialing down monthly Treasury purchases by $5 billion to $40 billion, while maintaining its buying of mortgage-backed securities at $40 billion, according to a Bloomberg News survey of economists. The FOMC has pledged for more than a year to press on with bond buying until achieving substantial labor market gains.
Builders began work on fewer U.S. homes than projected in August and applications for future work declined more than forecast, the Commerce Department said today. Housing starts rose 0.9 percent to a 891,000 annual rate, following the prior month’s 883,000 pace that was weaker than previously estimated.
The yield on the benchmark 10-year Treasury note rose 0.02 percentage point to 2.86 percent as of 9 a.m. New York time. Standard & Poor’s 500 Index futures expiring in December were little changed at 1,698.60.
“Fed leadership probably views MBS purchases as more effective in boosting economic activity than Treasury purchases,” Jan Hatzius, the New York-based chief economist at Goldman Sachs Group Inc., said in a Sept. 13 note to clients, referring to mortgage-backed securities. The central bank will probably curtail its monthly buying of Treasuries by $10 billion and not alter its level for mortgage bond purchases, he said.
Chairman Ben S. Bernanke and his policy making colleagues are debating how to scale back unprecedented stimulus aimed at stoking economic growth and reducing unemployment that was 7.3 percent in August. The Fed has held the main interest rate near zero since December 2008 and pushed its balance sheet to a record $3.66 trillion through three rounds of bond buying.
Fed officials such as Kansas City Fed President Esther George, who has voted on the FOMC this year against expanding stimulus, say balance sheet growth risks creating asset price bubbles and unmooring inflation expectations. George called this month for trimming monthly buying to about $70 billion.
In the first round of so-called quantitative easing starting in 2008, the central bank bought $1.25 trillion of mortgage-backed securities, $175 billion of federal agency debt and $300 billion of Treasuries. In the second round, announced in November 2010, the Fed bought $600 billion of Treasuries.
The FOMC began its current program in September 2012 with purchases of mortgage bonds, adding Treasuries in December.
Bernanke said in an August 2012 speech the first two rounds of quantitative easing provided “significant help to the economy” by boosting stocks and pushing down yields on mortgage-backed securities and government and corporate bonds.
The initial buying plan may have cut the yield on 10-year Treasury notes by between 0.4 percentage point and 1.1 percentage point, while the second program may have reduced the yield by between 0.15 percentage point and 0.45 percentage point, Bernanke said in the speech at Jackson Hole, Wyoming.
The two buying rounds “may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs,” he said.
The central bank gets a bigger payoff from buying mortgage-backed securities -- so-called MBS -- compared with Treasuries, said Arvind Krishnamurthy, a finance professor at Northwestern University in Evanston, Illinois.
“MBS purchases have more bang for the buck,” said Krishnamurthy, a former adviser to the Fed Board of Governors and the Fed district banks of New York and Chicago. “If the Fed was to decide that they want to reduce the size of their balance sheet but in a way that has less cost in terms of the stimulus that they’re providing, then it would follow that the appropriate strategy is to taper more on the Treasury side.”
Demand for mortgages has fallen as the average rate on a 30-year mortgage rose to 4.57 percent in the week ended Sept. 12 compared with a record-low 3.31 percent in November, according to Freddie Mac.
Home loan applications dropped 13.5 percent in the week ended Sept. 6 to the lowest level since October 2008, according to the Mortgage Bankers Association. Refinancing fell 20.2 percent to the weakest level since June 2009.
Purchases of new U.S. homes plunged 13.4 percent in July, the most in more than three years, with sales falling to a 394,000 annualized pace, according to the Commerce Department.
The biggest U.S. banks say the decline in loan demand may exceed expectations. San Francisco-based Wells Fargo, the top U.S. home lender, is cutting 2,300 jobs in mortgage production, while Bank of America Corp., based in Charlotte, North Carolina, has cut 2,100 positions.
Still, homebuilder confidence held in September at the highest level in almost eight years. The National Association of Home Builders/Wells Fargo confidence index registered 58 this month, matching August’s revised reading as the strongest since November 2005, according to a report yesterday from the Washington-based group.
Such optimism has found fuel from a recovery in home prices that pushed up the S&P/Case-Shiller index of values in 20 cities by 12.1 percent in June from a year earlier. The index surged 12.2 percent in the year ended in May, which was the biggest gain since March 2006.
“Housing has legs,” said John Silvia, chief economist at Wells Fargo in Charlotte, North Carolina. “But the overall sense in the U.S. is that it’s still not up to snuff, and I believe the Fed will want to stay away from the MBS and say, ‘Let’s just taper the Treasuries.’”