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Why the Fed’s monetary policy revived the housing sector

Phalguni Soni

Do mortgage rates follow movements in Treasury yields? (Part 3 of 9)

(Continued from Part 2)

Fed policy and the housing sector

The predominant factor in determining bond market returns during from January to April 2013 was the U.S. Federal Reserve’s accommodative monetary policy. The continuation in the Fed’s monthly bond purchase program at $85 billion per month, composed of $40 billion in agency-backed securities (VMBS) and $45 billion in longer-term Treasuries (TLT), was a large component of investor demand for these securities that helped shore up bond prices in the first four months of the year.

Further, the Fed’s policy of increasing market liquidity and lowering interest rates through open market purchases of fixed income securities has a lot to do with stimulating demand in the housing sector. Increasing housing demand is one of the biggest indicators of consumer confidence, as buying a home is a large investment and people show optimism toward their personal prospects and the prospects of the economy before buying a home. Investment in housing also has multiplier effects throughout the economy, notably in the construction (XHB) industry and companies in the home improvement sector, like Home Depot (HD) and Lowe’s (LOW).

Persistently low inflation and the unemployment rate were also responsible for keeping rates low and bond prices high. The Fed had indicated that it would maintain the Fed funds rate in the range 0% to 0.25%. It said, “At least as long as the unemployment rate remains above 61/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Inflation expectations form a significant component of long-term bond yields. Other factors remaining constant, the lower the inflation, the lower the interest rates, and vice versa. Since inflation and unemployment figures fell short of this target, interest rates stayed low and bond prices were high.

The Fed has since revised its full employment goals for the economy, stating that it would take a multitude of factors into account—the unemployment rate being one of them. “Of course, the unemployment rate is not a sufficient statistic to measure the health of the labor market,” said Fed Chair Janet Yellen in the second part of her testimony to the Senate Banking Committee last month, stating that the Fed would take other labor market indicators into account before looking at monetary tightening.

To learn more about how Treasury yields and mortgage rates reacted from April to October 2013, read on to Part 4 of this series.

Continue to Part 4

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