By
iShares ETFs
:
With the election and now the Fiscal Cliff taking over most of
the headlines the past few weeks, it's easy to forget that the
Federal Reserve is still in the midst of its efforts to boost the
economy. The latest round of easing, termed QE3, was launched about
two months ago. Let's take a look at how it has affected mortgage
rates and Treasury yields.
First, some background. On September 13th, the Fed announced
that as part of its effort to keep rates low until mid-2015, it
would implement QE3 and buy $40 billion of agency mortgage-backed
securities each month. These purchases are in addition to the $45
billion a month of long-dated Treasuries that the Fed is buying as
part of the
Operation Twist program
, which is scheduled to continue until the end of December. In
contrast, QE3 has an indefinite end date. It will be terminated
when the Fed believes it has effectively boosted employment.
In the initial weeks after QE3 was announced, the 30-year
fixed-rate mortgage rate did drop 33 basis points from 3.86% to
3.53%, according to the Mortgage Bankers Association. However,
after the initial drop, rates leveled off at 3.52% as of November
13th, despite the prospect of continued Fed purchases. Meanwhile,
the 10-year Treasury remained more or less flat, raising questions
about whether QE really works.
(click to enlarge)
There are a couple of things investors should keep in mind. First,
the market had anticipated QE3 long before it was officially
announced. A look through news archives shows that in January 2012,
Bernanke stated that housing market weakness was a significant
barrier to growth, leading to speculation that future easing could
focus on MBS. The Fed first extended Operation Twist in June,
before following up with QE3 on September 13th.
Second, the Fed can
influence
long-term borrowing rates but not
set
them. The Fed does set the Fed Funds Target rate, a short-term rate
that banks can borrow from the Federal Reserve. But the Fed cannot
directly set rates on Treasuries, mortgages, municipal or corporate
bonds. What it can do is embark on purchase programs such as QE3 in
an effort to push up bond prices and push down yields. Ultimately,
the Fed is just one (albeit large) player in the market, while
rates are determined by the supply and demand dynamics of
all
investors.
While the multiple rounds of quantitative easing have increased
the demand for Treasuries and MBS, resulting in higher prices and
lower yields, other market forces will ultimately determine the
level and rate of change of these rates. For example, after the
start of QE2 in November 2010, the U.S. 10-year actually rose from
2.62% to 3.73% by February of 2011. Fed action had encouraged
risk-seeking behavior from investors, pushing them into riskier
asset classes and out of less risky investments like Treasuries.
Less demand for Treasuries during this time period caused rates to
rise despite the Fed purchases. When considering the impact of Fed
actions on markets, it is important for investors to realize that
other investors' actions will have a significant impact on how
interest rates are affected.
Finally, the impact of QE3 has been to push mortgage rates
lower, though most of the decline was driven by concurrent declines
in Treasury rates. If we consider that the market probably began
pricing in QE3 from March 2012, the 30-year mortgage has dropped
from a high point of 4.19% to its current level of 3.52%, a drop of
56 basis points. Over the same time period, the 10-year Treasury
dropped from 2.02% to 1.69%, a decline of 33 basis points. Mortgage
investments generally kept up with Treasury investments over the
period. The Barclays U.S. MBS Index returned 1.85% on a total
return basis from 3/1/12 to 10/31/12.
What does all this mean for investors? First, my advice is to
stay informed about Fed policy and direction, as it impacts every
investor in the market. Second, understand that the end impact of
Fed policy isn't always as clear as it may at first seem. There are
a lot of other factors that contribute to the eventual direction of
interest rates and asset class returns. Third, remember that
diversification can be an investor's best friend, as it can help a
portfolio weather uncertainty, no matter which direction the Fed
heads next.
Source: Bloomberg
Original Post
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