The Fed, QE, tapering...what is it all and how come it affects mortgage rates?

It seems like all of our commentary lately mentions tapering, QE, and the Fed. Have you stopped to wonder what all the fuss is? You're not the only one. Today we will very briefly explain what the big deal is, and why it is important to you.

 

The Fed

The Federal Reserve, fondly referred to as "the Fed", is the central bank of the United States, whose job it is to provide the nation with a safe, flexible, and stable monetary system. At least, that's what it says on their website. What the Fed really does is control the flow of money and manipulates interest rates to control inflation, stimulate the economy, and keep the US out of recession (this is a very simplified explanation).

 

Quantitative Easing, or QE

One of the ways that the Fed manipulates the markets and interest rates is through Quantitative Easing - the act of buying specified amounts of long term financial assets, like Mortgage Backed Securities and US Treasuries. By buying these assets off of the market, it creates a demand for the supply, and helps to keep interest rates artificially low, stimulating lending (again, this is an oversimplified explanation). The Fed is current in the third round of quantitative easing since the "Great Recession" started, so we call the current round QE3. QE3 consists of the Fed currently buying $85 billion in assets a month (yes, a MONTH!) - $40 billion in MBS, and $45 billion in US Treasuries.

By buying these assets, the desired result is more activity and spending in the US economy, increasing economic output and creating jobs - essentially helping the economy stabilize and improve.

 

Tapering

So what happens when the Fed finally stops buying these assets (spending $85 Billion a month!)? Will they stop all at once?

When the Fed stops buying these assets, rates will increase - specifically for us, mortgage rates. Since the Fed doesn't want to see a sudden spike in rates that could be devastating to the economy, the Fed will TAPER their purchases - cutting them down over time until they are no longer buying at all. When the Fed does begin tapering, it will cause the value of these assets to decrease (again, this is an oversimplified statement of a very complex financial situation), meaning that traders will not want to take the loss. That's why traders spook at the thought of getting stuck with these bonds in their portfolio when they are losing value - and spook at the news that the Fed may begin tapering.

 

Summary

Since everyone is speculating when the Fed will begin tapering off their purchases, the markets watch the same indicators that the Fed does to gauge our economic recovery health and try to act before the Fed does. That's why our commentary constantly refers to this speculation - it moves the markets, causing mortgage interest rates to go up and down. When tapering is thought to be farther off, that is good for mortgage rates. When the fear arises that the Fed is going to act sooner than later, that is bad for mortgage rates. 

Want to read more about it? Here's an easy read article on Bloomberg.com that was a good read to give you some insight: http://goo.gl/8kHQ6B

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