More Fed Stimulus May Be Inevitable

If the Fed really cares about mortgage interest rates, then it's going to have to be more aggressive

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Although some economists were disappointed not to see the Federal Open Market Committee announce additional stimulus measures in its November statement on Wednesday, additional easing may be coming. In September, the Fed took modest measures meant to push down longer-term interest rates without actually increasing the size of its portfolio. The housing market was in its crosshairs. With mortgages rates stubbornly staying put, the Fed will have no choice but to be more aggressive if it wants to aid housing.

The Fed's Action Isn't Working

The Fed announced two policies that should have resulted in falling mortgage interest rates on September 21st. One aimed to push down longer-term interest rates generally and the other targeted mortgage rates in particular. Here's its progress report -- a chart showing the path of mortgage interest rates (the vertical green line represents when the Fed made its September policy announcement):

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You can see that rates initially began to fall for two weeks after the announcement, but then ticked back up. After remaining steady for a few weeks after that, they declined a bit again this week. But so far, the Fed's action hasn't produced dramatic results. Since the announcement, mortgage interest rates are down just 0.09%.

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And so far homeowners and prospective home buyers aren't impressed. From the week ending September 16 (before the Fed meeting) to the week ending October 28th, mortgage demand has remained weak. According to the Mortgage Bankers' association, over the period refinancing applications are actually down 7.2%. Purchase applications are up very slightly by 1.5%. As of the week ending October 28th year-over-year applications are down for refinancing and purchases by 18.2% and 2.3%, respectively. Certainly, the Fed must have hoped for a better result.

The Path Is Clear

So the Fed is going to have to act more aggressively if it hopes to cut mortgage interest rates by a more meaningful percentage. If you follow the views of the committee members, then it looks plausible that mortgage security purchases are coming. In recent weeks, various Fed officials have dropped several not-so-subtle hints.

Fed Governor Daniel Tarullo stated his view clearly a few weeks ago. Reuters reports:

"I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities," Tarullo said in text prepared for deliver at a conference at Columbia University. "There is need, and ample room, for additional measures to increase aggregate demand in the near to medium term, particularly in light of the limited upside risks to inflation over the medium term."

NY Fed President William Dudley appears to agree. He recently expressed disappointment in the effect of the new policies the Fed introduced in September and appeared open to mortgage security purchases.

Although no such action was taken in Wednesday's meeting, the biggest news from the statement was a dovish dissent. Chicago Fed President Charles Evans called for more aggressive action. So presumably, he'd be on board too.

Chairman Bernanke's words in Wednesday's presser also point towards mortgage security purchases. He was asked about the possibility of such an effort and responded:

I do think that purchases of mortgage-backed securities is a viable option. It's certainly something we would consider if conditions were appropriate. So the answer is "yes," we would certainly look at that.

If the board believed that conditions were appropriate to take actions to push down mortgage interest rates in September, then it should believe that mortgage security purchases would be sensible now: its September efforts aren't providing the desired positive effect on the housing market, so the picture hasn't changed.

At this point, we've got at least four voting members that have expressed clear openness bordering on willingness to engage in additional mortgage security purchases. Such action would almost certainly be more effective at pushing down mortgage interest rates. We didn't see a new program announced in November, but we may see some easing announced in mid-December. Three criteria must be satisfied for the Fed to increase its mortgage security purchases: a still-slow pace of hiring, mortgage interest rates remaining stubbornly above 4%, and inflation continuing to trend down.

Image Credit: REUTERS/Jonathan Ernst