This past Wednesday, the Fed has recommitted to operation twist at least through the end of 2012. The operation twist contains the selling or redeeming of 3 years or less maturities’ bonds on fed’s balance sheet, and use the sales proceed to purchase treasuries with maturity of 6-30 years. The twist comes from artificially lowered longer term interest rates due to the Fed’s purchase. Because of the fact that fixed mortgage lending rates in the U.S. are closely tied to the 10 year treasury yield, it is deemed this policy is beneficial to the mortgage refinancing market.
The Fed is also committed to the maturity extension program. It means that the Fed has previously purchased agency-debt and agency mortgage backed securities, and will continue to recommit all the cashflow from these securities to more agency debt and and agency mortgage backed securities purchase. This will also further lower the long term interest rate by providing support and liquidity for the agency debt and mortgage backed securities market.
During a news conference, Chairman Bernanke has reiterated the fed’s commitment of keeping short term interest rate low until at least 2014. Here is the Fed’s press release.
It seems that the Fed is opting to wait for signs of further global and U.S. economic slow down(meaning bad job numbers) to decide on the next round of Quantitative Easing.
The continuation of maturity extension program and operation twist are probably necessary but may not be as effective as when they were around for the first time. It is well known in finance and real estate mortgage business insider that those home owners that could refinance, already refinanced, therefore, unless there is a further lowering of underwriting standards, I really do not see refinancing and lowering borrowers’ cost of mortgage can further stimulate the economy significantly. Lowering 25 basis points does not have the same effect of lowering borrowing cost by a 100 basis points. Disposable income will not be impacted by much in the short term considering there is usually high closing cost associated with mortgage refinancing.
The other half of the picture is by lowering interest rate, the Fed hopes that it acts as a stimulation to the housing market, spurring buying interests and home prices. However, this half of the picture relies largely on two other factors, employment and to a lesser extent at least currently, in my opinion, household formation. Without stable paying jobs, it is difficult to have a consistent new crops of buyers to absorb the housing inventory. On top of that, shadow inventory is still a digestive issue that will take at least a few more years to work through the system.
On the other hand, I sincerely believe that many Asian countries housing markets have become somewhat frothy because of the economic expansion in the Asian economy, those places that have seen the greatest gain during the past 10 years with an unbalanced affordability will be most dangerous to some type of slow down. Beware my friends, forever rising housing prices is an urban legend, that the 99% main streeters can’t afford to gamble away on.
Bottom line: the global economy is sluggish. In my opinion, the Fed is very selective in firing its weapons because the timing is especially important because of two things: the Fed is running out of options and misfiring has dire consequences; and the failure of the Fiscal side to function due to gridlock. My dear readers, don’t get excited over Fed accommodation, because that is exactly the sign of a bad economy. Good luck navigating, and learn to protect yourselves with flexible, powerful, options strategies.