As mortgage rates inch upward on fears the Federal Reserve might slow
down its purchases of mortgage-backed securities, the chief of the Boston Fed
said Wednesday that the central bank should keep up its bond-buying program
until the economy shows more improvement.
Eric Rosengren, speaking in Minneapolis to the Economic Club of Minnesota, said the Federal Reserve should continue its aggressive strategy for holding down interest rates.
Rosengren, currently a member of the Fed's policy-setting Open Market Committee, said that when it does begin to scale back the program it must do so gradually.
"I do think we should treat this more like a dimmer switch," Rosengren said. "As we start seeing more evidence that the economy really is improving, as we're getting to a place where everybody would agree that it's substantial improvement in the labor markets, we do need to make some modest adjustments."
When those adjustments will be made is an important question for the bond markets, and other Fed officials have signaled a change could come sooner than had been thought. The speculation has helped drive up mortgage rates.
The Fed's balance sheet has quadrupled to $3.4 trillion in the past five years, mostly thanks to the central bank's purchase of $1.2 trillion in mortgage-backed securities since the end of 2008. The hope has been that the bond-buying will help drive down interest rates.
The move has had the intended effect on mortgages. Average 30-year fixed-rate mortgages reached a historic low at 3.31 percent in November 2012.
Rosengren gave no sign he is anxious to scale back the program, which purchases $85 billion in mortgage-backed bonds per month. U.S. unemployment at 7.5 percent in April is still too high, he said, and inflation -- the chief danger of easy monetary policy -- remains low.
"In my view it'd be premature at this time to stop our asset purchase program," Rosengren said. "We should wait until we see more sustained improvement in the labor markets."
But markets are scared of a Fed pullback. Mortgage rates have risen nearly a quarter of a percentage point to 3.59 percent since the beginning of May. That's partly because home prices are rising and belief in the recovery may be seeping into the bond market, but it's also because investors fear a Fed pullback is getting closer, said Scott Anderson, chief economist at Bank of the West.
Chairman Ben Bernanke spooked investors a week ago when he told Congress the massive stimulus program could be reduced at one of the "next few meetings" of the Federal Open Market Committee. Minutes from the committee's most recent meeting indicated some members were open to reducing the program as early as June.
"The comment that Bernanke made last week certainly changed some of the psychology in the market," Anderson said. "I don't know if that was intentional or not."
Whether the Fed slows asset purchases in summer or early fall, "both of those time frames are definitely accelerated from what the market was expecting," said Keith Gumbinger, vice president of HSH.com, a mortgage information firm.
So mortgage rates have risen as investors anticipate there being fewer buyers for mortgage-backed bonds.
"With a lack of demand, yields go the other way," Gumbinger said. "Essentially you're losing a big buyer in the marketplace."
The irony is that if the Fed slows its program, it will be evidence of economic progress, and Rosengren offered an optimistic assessment of the national economy. Employment is growing and unemployment is falling, if slowly, in almost every state, including Minnesota.
Wisconsin and Illinois have been exceptions, but they join North Dakota, Louisiana and Delaware in the extreme minority. States that were hardest-hit by the recession -- like California and Nevada -- are adding jobs quickly.
Meanwhile, inflation has remained historically low. Rosengren predicted GDP growth will accelerate from 2.25 percent through the first half of 2013 to near 3 percent in the second half of the year. He projected unemployment to fall to about 7.25 percent by the end of the year.
Anderson is less optimistic about the economy, citing weak manufacturing data, and argued investors shouldn't worry so much about the Fed stopping the bond-buying.
"I don't think the probability of a Fed taper is as high as the markets are pricing in right now," Anderson said. "When I look at the economic data, it's still pretty mixed."
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