BREAKING NEWS: No Rate Increase: YET, Says the Fed

The Federal Open Market Committee (FOMC) concluded its monthly meeting and issued its statement minutes ago. The big news is no change in Treasury and mortgage-backed securities (MBS) purchases and no change in the Federal Reserve target short-term interest rate. However, the Fed did leave the door open for future adjustments — rate increases and fewer bond purchases — and that sent rates up.

The Economy: Employment

Employment is still “well below pre-pandemic levels” for several reasons, and that’s a big reason for keeping interest rates low.

Federal Reserve Chairman Jerome Powell explained that finding new jobs takes time. In addition, many are concerned about exposing themselves to COVID in jobs working with the public.

Others, he elaborated, do not yet have access to child care and are unable to go back to work with their children at home.

Employment insurance payments, says Mr. Powell, are probably also holding some back from seeking work. Extended benefits will be expiring in coming weeks and months, and that will likely move more workers into the labor force.

The Fed projects unemployment to reach 4.5% by the end of this year and 3.5% by 2023

The Economy: Inflation

Inflation rose 3.6% in April, and Chairman Powell believes it will remain elevated before moderating. Higher oil prices, increased spending from pent-up demand, and supply bottlenecks are major factors in inflation.

Prices for things like lumber and used cars have been major drivers of cost increases to consumers. Bottlenecks have been worse than predicted and are causing higher-than-anticipated inflation. However, it’s expected to fall to 2.1% next year.

In addition, he warned, sudden shifts in consumer demand can still catch economists, businesses and companies off-guard during the economic recovery. This may cause additional bottlenecks and employment imbalances . Inflation could still change unexpectedly in the future.

There is some good news. Longer term inflation will soften next year, dropping back into the Fed’s target range of 2%. If it goes higher they will adjust monetary policy.

Federal Reserve and COVID

Vaccination pace is slowing, and new strains are elevating the risk of COVID. This, Mr. Powell stated, is  interfering with the US economic recovery. Mr. Powell explained that the Fed will continue to promote maximum employment and stability in financial systems. Inflation will be allowed to exceed 2% for a short period because it was much lower during the depths of the pandemic. The Fed will allow it to go a bit higher to achieve an average of 2%.

Don’t Expect Sudden Moves

Chairman Powell stated that the Fed will maintain an “accommodative” stance to stabilize financial markets and achieve maximum employment.

“Whenever liftoff comes, policy will remain highly accommodative,” he said. While the Fed is supporting low interest rates by purchasing $80b in Treasuries and $40b of mortgage-backed securities (MBS), Mr. Powell indicated that purchases can be increased if necessary to support the economic recovery.

He assured Americans that the Fed will provide advance notice of changes to these important policies.

What Does “The Fed” Do?

When most people talk about “The Fed,” they usually mean the Federal Open Market Committee, or FOMC.

This committee controls the money supply in the US. The  Federal Funds Rate, which is the rate that banks pay to borrow money overnight, is one tool the Fed uses to impact the money supply. The amount of reserves it requires banks to hold is another. By raising the Federal Funds rate or increasing required reserves, the Fed lowers the money supply. That helps control inflation.

By lowering the Fed Funds rate or lowering reserve requirements, the Fed increases the money supply. That helps support the economy when it’s troubled. It’s a tricky balancing act, controlling runaway inflation and avoiding recession.

The Fed Does Not Affect Mortgage Rates (Usually)

The Federal Funds rate is a short-term rate. Depository institutions like banks must hold some of their money as reserves and cannot invest it or loan it out. That’s so banks always have money to pay their depositors when they want it.

Banks often borrow to balance their cash flow and keep as much of their money working as they can. The Fed establishes the rate at which banks borrow these funds overnight.

The rate for these short-term loans does impact credit cards, home equity lines of credit and other short-term borrowing. It affects the Prime Rate. Construction loans and other products with variable interest rates can change when the Fed alters its short-term rate.

But mortgages are long-term transactions with most rates fixed for many years. Movements in short-term rates have little impact.

The Fed does more than just set its Federal Funds rate. It also gives economic guidance to market participants.

For mortgage borrowers, what the Fed says about inflation is key. Inflation is the enemy of mortgage bonds.  In general, when inflation pressures grow, mortgage rates rise over time.