The simple answer is that the Federal Reserve Bank (the “FED”) continues to modify and adjust its policy.
The reason for the change in FED policy was that the inflation that began in 2021, which originally was ignored and downplayed by the FED, has exploded in 2022. The causes of current inflation include but are not limited to economic data in the US, massive government spending in 2020 and 2021, the ongoing pandemic that affected the price of other goods due to supply chain disruption, the increase in energy cost as a result of policy changes and made worse by the war in Ukraine that has affected the price of all commodities (oil, gas, copper, industrial materials, etc.…). Controlling Inflation is one of the two primary policy goals of the FED and to this point its policies have failed to control inflation.
The expectation by the financial markets is for inflation to continue to grow which caused interest rates to rise in anticipation of future FED actions, including their state objective to increase the FED Funds Rate and to substantially reduce the purchases of Mortgage-Backed Securities. It is noteworthy to note that during the first quarter of 2022, the FED has confirmed that the market is right to be afraid of its change in policy.
This sums up the big problem for mortgage interest rates so far in 2022 and the reason for the unprecedented increase in mortgage rates at the fastest pace, in a similar time frame, since 1994.
For the week ending March 31, 2022, the average 30-year fixed mortgage interest rate, published by Freddie Mac, rose to 4.67% nationwide. This rate was approximately 3% on January 1, 2022. This is the highest level for interest rates since December 2018 and the sharpest increase in mortgage interest rates in such a short timeframe since 1994.
BACKGROUND ON FED POLICY
Fed policy involves setting the key overnight lending rate in the US (the Fed Funds Rate) as well as deciding when to buy and sell large amounts of various types of bonds.
The types of bonds purchased by the FED include US Treasuries and Mortgage-Backed-Securities (MBS). The MBS market directly influences mortgage rates. As a result, the Fed policy for purchasing MBS bonds has a direct and significant impact on mortgage rates. If the Fed gives the market a reason to expect smaller MBS purchases, mortgage rates will rise.
Starting in November 2021, the Fed began reducing the size of its bond purchases that began at the start of the pandemic. This was bound to happen at some point, but November was a bit earlier than financial market experts had expected. As a result, MBS suffered, and mortgage interest rates began to rise. 30-year mortgage rates were as low as 2.5% in the fall of 2021, prior to this announcement.
In December 2021, the Fed announced it would decrease MBS purchases at a faster pace than previously announced in November. At the beginning of January 2022 mortgage interest rates had risen to just above 3% following the December announcement.
On January 5th, 2022, the minutes from the December’s Fed meeting were published. The minutes are closely reviewed because they often reveal additional details that didn’t make it into the official policy statement released immediately following the meeting (generally three weeks earlier). When the minutes were released, it was learned that the Fed was discussing decreasing the purchase of MBS bonds at a faster pace than previously announced. More concerning was that the FED had also been discussing a faster pace of rate hikes for the Fed Funds Rate. While the Fed Funds Rate does not directly govern mortgage rates, if the market suddenly expects more/faster increases of the Fed Funds Rates, all types of interest rates will increase at a faster pace, including mortgage rates.
Following the January 5 meeting there was an immediate shift in rate hike expectations. With the Fed Funds Rate in the 0.25-0.50 bracket at the beginning of November 2021, it will require EIGHT rate hikes in the standard 0.25% amount to hit the current 2022 year-end target of 2.5% to 2.75%. There are only 6 Fed meetings remaining! So at least 2 of those meetings will require a 0.50% hike. It has been more than 20 years since the FED has increased the FED Funds Rate 0.50% following a meeting.
This rapid repricing of expectations is the cause of volatility in interest rates right now. The decrease in MBS purchases by the FED is also a large factor in the increase in mortgage interest rates in 2022.
There is hope on the horizon. The higher rates go and the faster they get there, the sooner we will see a stable and predictable interest rate environment return. This can happen even as the Fed continues to hike rates because the mortgage and Treasury markets anticipate interest rate changes based on future expectations and move in advance of the FED announcing any actions. When the future plays out as expected, rates generally do not continue to increase and often will decline.
Any additional surprises will depend on incoming data and events–especially inflation related data and geopolitical events that greatly affect the outlook for growth or inflation.