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Potential for Fed rate hikes another reason mortgages are pricy

Jun.25, 2008 in Market Outlook

Fed rate hike concerns doing no favors for mortgage market

Signals from Fed may provide clues for whether mortgage rates will cool

By Deborah Levine, MarketWatch

Last Update: 6/25/2008 10:10:00 AM

NEW YORK (MarketWatch) — Expectations the Federal Reserve will raise benchmark
interest rates is not helping the housing market, which is likely to stumble
along for months as long as homeowners find it costly to borrow.

The trouble, say bond managers, lies in the link between mortgage rates and the
institutional investors that buy mortgages after the bank originates the home
loan. When pension and hedge funds snapped up mortgage-backed debt, their demand
paved the way for banks to offer more mortgages and keep rates low. But as
mortgage defaults soared in the past year, those investors stayed away, pushing
rates higher.

More recent speculation the Fed will hike rates this fall has pushed leery
investors further onto the sidelines. That’s translated to pricier home loans:
The rates on traditional 30-year fixed-rate mortgages are at 6.42%, the highest
since September, says Freddie Mac.

“The market is fixated on the possibility that the Fed is concerned about
inflation and will raise rates,” said Scott Kirby, sector leader for structured
products at RiverSource Investments, which manages $93 billion in assets. “That’s
pushed mortgage rates higher.”

For these reasons, mortgage-debt investors and lenders will be scouring the Fed’s
statement for clues on future rate hikes and the housing market when the U.S.
central bank ends its two-day meeting at 2:15 p.m. Eastern.

Signs that the Fed will raise rates soon could act as another blow to homeowners.

Another reason to stay away?

The recent upswing in mortgage rates stems from comments from Fed Chairman Ben
Bernanke and other policy makers. Their worries about commodities inflation have
propelled odds the Fed will start increasing its overnight lending rate in the
next two months.

The futures market recently priced in a 43% chance the Fed would raise rates in
August by a quarter point and a 60% chance that rates by increase to 2.75% by
November.

Investors in mortgage debt had already left in droves - even while Fed the
slashed its overnight lending rate by 3.25 percentage points, to the current 2%.
They stayed away after plummeting home prices sent delinquencies to their highest
levels since 1979, according to Mortgage Bankers Association data. And they have
continued to receive a steady stream of bad news in recent weeks.

On Tuesday, the Case-Shiller index said home price depreciation has wiped out
four years of owners’ gains in the value of their homes.

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