Yesterday’s announcement from the Fed’s quarterly meeting was a major market mover–especially for mortgage rates. Ben Bernanke announced the initiation of something called ‘operation twist’, which many market observers were prepared for, but my understanding is the tone of the announcement really made the bond market jump to levels never before seen, with the result being the lowest mortgage rates ever seen in the US. I get some great information from a market analyst in the Chicago area named Doug Nardi, and I’m copying and re-posting his assessment for you, here:
The Federal Reserve’s Operation Twist was everything it was cracked up to be, and even a bit more. While the stock market was less than impressed with the central bank’s latest stimulus plan, the bond market was all for it. The Fed announced it would direct $400 billion from the sale of treasuries of three years and less in duration and invest it in those with maturities of 6 to 30 years.
The total was about $100 billion more than expected and an indication that the Twist–which seeks to lower long-term borrowing costs (mortgage rates mainly) by compressing the yield curve for government debt–was on in a big way. Listed below is an excellent synopsis from our research partner ISI of today’s Fed actions.
1. Summary – The Federal Reserve decided to engage in operation twist as widely expected. The size, however, at $400 billion, was larger than expected. The Fed also decided to reinvest proceeds of maturing agency and mortgage securities into more mortgages instead of into Treasuries. The Fed’s outlook is bleaker than last time, with now “significant downside risks.”
2. Growth Outlook – There weren’t many significant changes in the first two paragraphs of the statement, but the assessment that risks are now significantly to the downside is notable. Overall, the Fed has probably further reduced its expectations of what growth is likely to be in coming quarters.
3. Inflation Outlook – No concern at all on the inflation front. The statement said that “inflation appears to have moderated” from earlier in the year, even if the most recent CPI is at 3.8%. The Fed thinks that the combination of a weaker economy and the recent decline in commodity prices will result in lower inflation going forward.
4. Policy Stance – The Fed decided to sell $400 billion of Treasuries with remaining maturity of 3 years or less and to buy the same amount of Treasuries with maturities of 6 to 30 years. According to the table released by the NY Fed, re-investments will be as follows: 32% of the total between 6-8 years; 32% between 8-10 years; 4% between 10-20 years; 29% between 20-30 years; 3% in TIPS between 6-30 years. The amount in 20-30 years is larger than expected, hence the large drop in the 30 year Treasury yield.
The Fed also decided to reinvest the proceeds of maturing agency and mortgage securities in other mortgages instead of in Treasuries. The estimated amount is about $20 billion per month or maybe slightly more, depending on refinancing activity. This could be significant because it could lower mortgage rates by reducing the spread of mortgage securites to Treasuries.
The Fed maintained its conditional commitment to keep short rates very low until at least mid-2013.
5. Looking Ahead – The Fed maintained an easing bias, so it is prepared to do more should the economy not improve. At least part of that may come through the communication of what it will take for the Fed to raise rates. The aim would be to make it clear that rates will not increase for longer than the 1.75 years currently in the statement. That should keep the yield curve lower and anchor yields even beyond two years, thus further motivating investors to buy risky assets. We will have to wait for the minutes of the meeting and other communications to see if this is something we can expect to see happening in the relatively near term.
What this means for mortgage holders is that this week is an unprecedented opportunity to lower the cost of your debt. Don’t forget that lowering your rate gives you two choices:
1. You can have more money each month to direct to other debts or future savings/investments, or:
2. You can accelerate the payoff of your mortgage entirely.