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Economic Currents

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Q&A: Fed Act to Lower Mortgage Rates

Posted September 22, 2011 | Categories: Q&A
1. The Federal Reserve met for a two day meeting on Tuesday and Wednesday. After their meeting, the stock market fell sharply Wednesday afternoon and Thursday. What did they do!

The Federal Open Market Committee (FOMC) met on Tuesday and Wednesday to discuss the state of the US economy and to decide on monetary policy actions. The last time they met back in August in their post meeting statement they said that "downside risks to the economic outlook have increased", and "that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013." They updated their outlook this week basically telling us that the economy is facing more than just a temporary slowdown acknowledging that "there are significant downside risks to the economic outlook" and that global financial market turmoil is a significant risk.

2. But isn't the problem that the Fed really can't do much more with short term interest rates at near zero?

The Fed's traditional monetary policy tool—short term interest rates—are near zero and are expected to stay there. That is one possible reason for the decline in stock markets is the fear that the Fed is out of tools, and the recognition of the significant downside risks. What the fed did was announce two changes in policy that are aimed at lowering long term interest rates.

3. You mean what people are calling operation twist?

Operation twist was just one of the changes. Basically between now and June 2012, the Fed will sell short term (3-years or less) treasury securities and purchase, $400 billion of long-term (6-30 years)Treasury securities. The result will be downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The other change specifically targets mortgage rates. On Monday, October 3, the Fed will begin reinvesting "principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities." This differs from the current practice of reinvesting principal payments from holdings of agency debt and agency MBS in Treasury securities. The result will be some downward pressure on mortgage rates.

4. We just received some additional news on Hawaii economic growth this week as well, what was that?

On Thursday, the Bureau of Economic Analysis released its quarterly State Income data. Nominal income growth for the second quarter of 2011 places Hawaii 45th out of all 50 states, with annualized growth of less than 4% compared with the first quarter of 2011. These numbers are broadly consistitent with the UHERO forecast released at the end of last month which documented the slowing growth since the end of 2010.

-- Carl Bonham

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