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A Fed liftoff may not move long-term mortgage rates

Most economists and Wall Street now believe the Federal Reserve will announce on Wednesday the first hike in the short-term interest rate in nearly a decade.

But analysts are far less sure of when, and by how much, long-term mortgage rates will rise.

During a webinar on Tuesday, Andrew Lyon, a former U.S. Treasury official who now directs the economics group at PricewaterhouseCoopers, and National Association of Realtors Chief Economist Lawrence Yun made a case that economic conditions seem right for the Fed to raise the federal funds rate several times over the next couple of years.

The impact on mortgage rates is less clear, however. The economists pointed out that the Fed has less control over the movements of longer-term rates, which are tied more closely to 10-year Treasuries.

Yun said that mortgage rates are influenced by inflation, inflationary expectations and global conditions and flows of capital. A continued low level of inflation at around 1.5 percent, in particular, could keep mortgage rates in check, Yun said.

“A host of other factors are in play that makes it move somewhat independent of the short-term rate at times,” Yun said.

The economists also generally downplayed any negative impacts on the housing and mortgage markets.

Rates should remain favorable

“By historical standards we have had very low interest rates,” Lyon said. “If the federal funds rate increases over the next three years toward the Federal Reserve’s new target of about 3 ½ percent and if we think that adds roughly 3 ½ percent to the one-year rate, those short-term rates will still be very low by historical standards. Even if we added a percentage point to the 10-year rate, that too would be a very low historical rate.”

The Fed’s Federal Open Market Committee (FOMC) met on Tuesday, and Fed Chair Janet Yellen is scheduled to hold a news conference on Wednesday. Lyon said that while the expected rate increase "is not a foregone conclusion," the futures market on the Chicago Mercantile Exchange placed an 81 percent probability that the Fed will announce a first liftoff. He also noted a recent survey of economists indicated that the vast majority are also betting on an increase. 

“Hopefully we are now moving to a stronger economy,” Lyon said. “Even as the Fed begins this policy of rate increases, if they begin that tomorrow as expected, it will still be keeping us in a favorable interest rate environment.”

Yun said that he expects a first increase on Wednesday and then three short-term rate increases in 2016, which will put the Federal funds rate at 1 percent or 1.25 percent. He predicted that long-term rates will rise to around 4.5 percent to 5 percent by the end of next year.

Yun said home sales tend to decrease when rates rise, but this time other variables are in play. He mentioned that credit has eased and the economy has added jobs, factors that should offset the negatives to the housing market from rising rates.

Rising interest rates could have more impact on commercial markets, which have seen prices rise to record highs and capitalization rates fall significantly in major markets, Yun said. If interest rates rise, investors will demand higher cap rates and that could bring down values of trophy properties. 

"Rents need to be much higher or property values have to come down," Yun said.   


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