In the just-released FOMC statement, the Fed announced a 0.75% hike in the Fed Funds rate (+75bps). This was a departure from the explicit guidance they had given that the next several FOMC meetings would result in 50bps rate hikes.
The statement will cite their reasons for taking this extraordinary step, but it is clearly due to two reasons. First, the May CPI report last Friday showed inflation at the consumer level is still accelerating, not leveling off as was thought in May. Second, recent data also suggests that inflation expectations are increasing.
Don’t discount the latter. History proves that psychology plays a significant role in high inflation environments. The Fed taking this step to break with their carefully crafted guidance can only be seen as how necessary they see the need to get back in front of these inflation expectations.
Not to be overly dramatic, but this 75bps move is the largest single Fed Funds rate increase since 1994. And even the 50bps increase in May was the first of that magnitude since 2000. These moves, especially today’s 75bps increase, raise the risk that markets will fear the Fed has lost control of the ability to tame inflation. That raises the risk that orderly market function will degrade, in bonds and in equities. Orderly markets has always been the third silent mandate for the Fed. That’s also a factor with today’s action.
The Fed knows all too well they must get inflation to start heading lower as soon as possible. That will begin to restore the market’s confidence in their ability to gain control over inflation. But more of these extraordinary policy moves bring into question the possibility they cause a recession. The Fed is on a very slippery slope now.
The tone and additional guidance in the announcement, today’s revised SEP dot plots, and Chair Powell’s press conference that follows will help the market understand how the Fed has reset their policy plans going forward from here. Given the break from the recent guidance, re-establishing forward guidance has a difficult course to navigate. And the Fed has to re-establish their credibility quickly.
What’s Next?
In light of this action and the continuation of the Fed‘s MBS purchase runoff campaign, the MBS TBA market will continue to be subject to a high level of volatility. And regaining the ordinary premium levels that have been absent since March will take longer now, and that will result in originators continuing to price with unusually high levels of discount points and navigating points & fees and APOR compliance violations.
There’s no certain way to predict how quickly premium levels will return, but an MBS TBA market not subject to a constant push by the primary market into higher coupons is a requisite. And that hinges on the bond markets regaining faith that the Fed’s inflation campaign is at least beginning to take effect. Meanwhile, the pace of the economy will set the stage for any recession expectations and the rate relief that could bring. We’re still a ways away from that.
What Do Borrowers Do Now?
In these uncertain times, bond market volatility is at a high level. Volatility refers to the amount prices (or yields, rates) are expected to rise and fall over a short period of time, typically 30 days. This level of risk is priced into option markets and makes forward settlement rates more expensive. All rate lock pricing operates in forward settlement markets, so this directly impacts rate pricing from day-to-day.
A heightened level of volatility makes waiting to rate lock a greater risk. Therefore, getting rate locked as soon as possible to avoid the heightened risk of (even) higher rates should be every originator’s standard operating procedure for the foreseeable future.
Originators should explain to borrowers who want to finance the purchase of a home that the current mortgage rate market is more expensive because of the higher level of uncertainty in the bond markets – due to the Fed’s evolving monetary policy struggle to contain inflation.
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