Fed Chair Jerome Powell says policymakers are not ready to start selling off Treasurys and mortgage debt to accelerate the balance sheet runoff.

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Mortgage markets look to have already priced in a fourth drastic hike in short-term interest rates this year as the Federal Reserve continues to wage what’s proved to be a difficult fight against inflation.

Despite the Fed’s aggressive messaging around Wednesday’s 75-basis point increase in the federal funds rate to 3.25 percent, mortgage rates — which have recently surged to levels not seen since 2008 — may be poised for a breather.

Yields on 10-year Treasurys, which are seen as a barometer for mortgage rates, eased after the conclusion of Wednesday’s meeting as Federal Reserve Chairman Jerome Powell provided insights into the Fed’s thinking.

Russia’s war against Ukraine has boosted prices for energy and food and created additional upward pressure on inflation, Powell said at a press conference following the conclusion of the Federal Open Market Committee’s two-day meeting.

While the Fed is likely to continue its current strategy of aggressive short-term interest rate hikes, Powell provided assurances to bond market investors that the central bank is not looking to further accelerate the pace at which it unloads Treasurys and mortgage debt.

In addition to anticipating that additional increases in short-term rates “will be appropriate,” Fed policymakers said they will continue to trim the central bank’s nearly $9 trillion balance sheet by shedding $60 billion in Treasurys and $35 billion in mortgage debt each month.

But Powell said, for now, the Fed is content to trim the balance sheet by simply letting expiring assets roll off the books without replacing them. In the past, Fed policymakers have said they would also consider selling Treasurys and mortgage debt if needed to accelerate “quantitative tightening,” which would put more upward pressure on mortgage rates.

“We said we would consider that once balance sheet runoff is well under way,” Powell said. “It’s not something we’re considering right now and not something I expect to be considering in the near term. It’s something we will turn to, but the time for turning to it is not close.”

With one measure of inflation, personal consumption expenditures, running at a projected 5.4 percent this year and not expected to return to the Fed’s target of 2 percent until 2025, Fed policymakers see little room for complacency in raising short-term rates, Powell said.

“The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched,” he warned. “We are guided by promoting maximum employment and stable prices for the American people.”

Mike Fratantoni

Economic projections by Fed policymakers “indicate slower growth, slowly decelerating inflation, and a fed funds rate that will likely top out well above 4 percent,” said Mortgage Bankers Association Chief Economist Mike Fratantoni in a statement. “The surprise for the market might be the median expectation that they could increase [short-term] rates to 4.4 percent by the end of this year.”

While some economists and bond market investors have been betting that the Fed will have to slow the pace of rate increases if growth stalls — and possibly reverse them if the economy enters a recession — Powell seemed intent on quelling such speculation.

“So far there is only modest evidence that the labor market is cooling off,” he said. “Job openings are down a bit. Quits are off their all-time highs. There’s signs that wage measures may be flattening out. Payroll gains have moderated, but not much.”

Historically, the Fed has raised the federal funds rate by 25 basis points at a time when it wants to cool down economic growth. A basis point is one-hundredth of a percentage point, so it usually takes four 25-basis point increases to raise the federal funds rate by 1 percentage point.

That’s how the Fed started out this year, raising short-term rates by 25 basis points on March 17. When that didn’t have the desired effect, the Fed implemented a 50-basis point increase on May 5.

As inflation continues to defy expectations, the Fed has implemented three 75-basis point increases at its last three meetings, on June 16, July 28 and Sept. 21.

All told, the Fed has increased short-term rates by 3 percentage points this year and shows little sign of dialing back the pace.

Before making smaller increases, let alone halting rate hikes, Powell said the Fed would want to see “growth continuing to run below trend, to see movements in the labor market showing a return to a better balance between supply and demand, and clear evidence that inflation is moving back down to 2 percent.”

“In terms of reducing rates, we’d want to be very confident that inflation is moving back down to 2 percent before we would consider that.”

In a note to clients, Pantheon Macroeconomics Chief Economist Ian Shepherdson expressed his surprise that the Federal Open Market Committee’s policy statement contained “Not a word about the startling meltdown in the housing market.”

Shepherdson said he now expects the Fed to implement another 75 basis-point increase in the federal funds rate in November, but to revert to a more traditional 25-basis point in December.

“The Fed will have seen only one more round of inflation numbers by November, but three more by December, and we expect them all to be much better than in August,” Shepherdson said.

In their latest forecast Wednesday, economists at Fannie Mae signaled they no longer expect mortgage rates to fall back below 5 percent next year.

Mortgage rates no longer projected to ease

Source: Fannie Mae Housing Forecast, September 2022

In August, Fannie Mae predicted 30-year fixed-rate mortgage rates would peak at 5.2 percent this year and retreat to 4.4 percent during the second half of 2023. Now, it expects mortgage rates to peak at about 5.7 percent and retreat only modestly to 5.5 percent by the final three months of next year.

Economists at the Mortgage Bankers Association projected in a Sept. 19 forecast that rates will peak at 5.5 percent in the second half of 2022 before falling back down to 5.0 percent by the end of next year.

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Email Matt Carter

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