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Search Home Blog Home Site Home Search -- Categories financial planning foreclosures Government Programs/Legislation home prices Interviews mortgage refinancing news Links Loan Bark Lenderama Calculated Risk About.com Home Buying I Am Facing Foreclosure CNN Real Estate Warren Reports Mortgage Fraud Blog Mortgage News Daily The Mortgage Reports Return to Content Navigation Federal Reserve Lowers Fed Funds Rate Twice on Coronavirus Fears Published on Tuesday March 17, 2020 at 10:59 am The Impact of Fear on Economic Activity When people are fearful they tend to cut back on consumption outside of fear-based purchases like toilet paper, cleaning supplies, face masks, guns and gold. If the fear is widespread enough financial asset prices can sell off, further boosting fear, leading to a doom loop cycle where the financial abstractions of the economy lead the real economy lower as the opposite of the wealth effect takes place. How Big is Travel? Travel and hospitality account for about 15% of the domestic economy. Many other businesses like bars & restaurants are shut down or only allow to-go orders. The United States has run a large and growing goods trade deficit with China for decades. Chinese students attending universities and Chinese tourism have been strong services exports for the United States. Airplanes manufactured by Boeing are also a large export. The Federal Reserve Fights Back The Federal Reserve has moved to try to offset some of the adverse impacts of COVID-19. On March 3, 2020 the Federal Reserve Open Market Committee (FOMC) lowered rates from 1.75% to between 1% to 1.25%. Last Sunday the Federal Reserve slashed the federal funds rate by a percent down to 0.00% to 0.25%, making their March 15 cut the second emergency rate cut in 13 days. On Sunday the Federal Reserve also announced $700 billion worth of quantitative easing, with $500 billion going toward Treasurys and $200 billion going toward mortgage-backed securities. The goal of these moves is to lower the hurdle rate for investments while lowering the carrying cost of debt for companies and flooding the market with liquidity to offset forced position liquidations caused by the crisis. Does the Federal Reserve Control Mortgage Rates? The Federal Reserve controls the short end of the yield curve, but the longer end of the yield curve has been falling throughout the year as well on coronavirus-driven recession fears. The longer end of the curve is controlled in part by inflation expectations along with factors like liquidity and the balance of fear versus greed in the capital markets. If investors perceive risk to be low they generally prefer to invest in higher returning equities over lower returning bonds. If investors perceive risk to be high they prefer shorter-duration high-quality liquid bonds to more speculative equities. The 30-year fixed rate mortgage tends to track the 10-year Treasury at a slightly higher yield. The following FRED graph shows how both the 15-year & 30-year fixed-rate mortgage rates closely track the 10-year Treasury versus the Fed Funds rate. Mortgage rates tend to track moves in the 10-year Treasury. In spite of loans being offered for 30 years, many people move homes or refinance their loans roughly every 7 to 12 years, making the 10-year a better duration match for the typical mortgage than the 30-year Treasury Bond. Zooming in more closely on the graph you can see how in recent weeks as government stimulus measures worked their way through Congress both the 10-year and mortgage rates shot up, even as the FOMC dropped the Fed Funds rate to 0.0% to 0.25%. Mortgage rates followed the 10-year Treasury Note yield higher. Increased fiscal stimulus lowers the risk of a deep recession & increases inflation expectations, this can in turn cause bonds to sell off, boosting their yields. Rate Type 1-9-20 3-5-20 3-19-20 Fed Funds Rate 1.75% 1-1.25% 0-0.25% 10-Year Treasury 1.85% 0.92% 1.18%* 15-Year Fixed Mortgage 3.07% 2.79% 3.06% 15 MRT vs 10 yr Treas. +1.22% +1.87% +1.88% 30-Year Fixed Mortgage 3.64% 3.29% 3.65% 30 MRT vs 10 yr Treas. +1.79% +2.38% +2.47% *data from 3-18-20 As shown in the table above, mortgages trade at around 1.5% to 2.5% higher yields than the 10-year Treasury. Purchasing mortgage-backed securities should tighten this spread by driving down the yields on MBS, which should lower interest rates on mortgages. This process has pipeline effects which take time to work their way through the economy. At the end of April Freddie Mac’s data showed the 30-year reached a record low of 3.23% and the 15-year dropped to 2.77%. While there are multiple related layers of uncertainty and volatility in the market, rates may decouple from the 10-year : Uncertainty surrounding the coronavirus outbreak has bred volatility in mortgage rates. The usual indicators of where rates are headed — namely the yield on the 10-year Treasury — are no longer reliable predictors. Instead, what is having a greater effect on mortgage rates is the capacity of lenders to handle the huge volume of refinances brought on by lower rates and the increasing amount of mortgage-backed securities the Federal Reserve is buying. How do Homeowners React to FOMC Rate Moves? Over the years numerous surveys have shown roughly a quarter to a third of homeowners do not know what their mortgage rate is. While many homeowners do not know what their rate is, Federal Reserve moves are widely covered in the news. This leads to a surge in consumer demand. The following picture shows traffic to this website. The light blue line shows a huge spike on a Sunday after the Federal Reserve announcement. Huge traffic spike on Sunday from the second Federal Reserve March rate cut announcement. People who are consumed by fear or worried they may lose their job will be less likely to take on large sums of debt or make bit life choice changes, thus when there is major volatility and uncertainty people are less likely to buy a home using credit. Roughly 88% of residential homes purchased by homeowners are purchased using financing. Those who already own homes see news of decline in market rates and quickly check to see how much money they can save. As of the end of March the MBA recently stated that refinance volume has increased in share to where it now represents 75.9% of total mortgage applications. How is the Mortgage Market Structured? Individual home loans created by lenders can be held in their company portfolio or can be sold off into the secondary market. Before selling loans off into the secondary market lenders group them into a mortgage-backed security. Government sponsored entities (GSEs) Fannie Mae and Freddie Mac guarantee MBS which contain conventional mortgages. The Department of Veterans Affairs guarantees VA loans while the USDA guarantees some rural loans and the FHA helps lower risk on some loans issued to low-income homeowners and other groups. Historically most of the mortgage loan origination market has been dominated by large banks like Wells Fargo, Citigroup, Bank of America, U.S. Bank, and J.P. Morgan Chase. Due in part to regulations enacted after the Great Recession in recent years banks originated around half of home loans while the other half of home loans are originated by firms specializing in mortgage loans like Q...