High inflation and a strong labor market has convinced Federal Reserve officials of the need to raise interest rates “soon,” though an exact timetable has not yet been disclosed.
“With inflation well above 2% and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,” the Federal Open Markets Committee said in a statement on Wednesday.
The FOMC decided on Wednesday to keep the target range for the federal funds rate at 0 to 0.25%, but will likely take action on rates in early March.
Policymakers at the central bank said that beginning in mid-February, it will purchase $20 billion in Treasury securities and $10 billion in mortgage backed securities. The previous plan, from January, indicated purchases of $40 billion in Treasury and $20 billion for MBS. The asset tapering program is scheduled to end in early March.
For the mortgage industry, the announcements of a rate hike and the end of the pandemic-era asset purchasing policy signals heightened pressure on mortgage-backed securities and higher rates on loans in 2022. Mortgage rates are already above 3.5% for a typical 30-year mortgage, and trade group the Mortgage Bankers Association has forecast mortgage rates to climb to 4% by the end of the year.
After raising interest rates, the FOMC agreed that it will reduce the size of the central bank’s balance sheet over time in a predictable manner, primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA).
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“In the longer run, the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy,” the FOMC said.
Regarding the pandemic and the omicron variant, the FOMC said the “path of the economy continues to depend on the course of the virus,” though it expressed optimism that economic conditions were improving.
In a note on Wednesday, Mortgage Bankers Association’s senior vice president and chief economist Mike Fratantoni said that it’s worth watching how the Fed will reduce its $9 trillion balance sheet, which is expected to be quick and at a faster pace once it starts.
“The principle that they would like to return to a balance sheet that is primarily Treasuries at some point hints at some additional pressure on MBS yields over the medium term,” Fratantoni said in a statement.