Fed’s new inflation policy could push mortgage rates up
Federal Reserve President Jerome Powell on Thursday announced a major change in monetary policy that will allow the central bank to use average inflation, rather than the current practice of setting a hard target.
Speaking in a video version only of the Kansas City Federal Reserve BankPowell said the Fed will no longer hike its benchmark rate to keep unemployment from falling too low and allow inflation to slightly exceed the current 2% target after periods of economic weakness.
Both of these measures could be good for workers looking for pay increases, said Dean Baker, senior economist at the Center for Economic and Political Research. The downside is: higher inflation would put upward pressure on mortgage rates.
“I know nobody wants to pay more mortgage rates, but if their wages are rising faster because of today’s change in Fed policy, it ends up being a wash, ”Baker said in an interview.
Mortgage bond investors use inflation as the mainstay of their calculation that determines the return, or return, they are willing to accept. Because higher inflation eats away at bond yields, investors demand a higher yield for the mortgage-backed securities and other bonds they buy when inflation rises. Inflation fears are also boosting yields on Treasuries, which are used as a benchmark for MBS investors.
The Fed’s new policy will likely keep its overnight interest rate at its current near zero level for years as the economy recovers from the recession caused by the COVID-19 pandemic. This keeps rates low for home equity lines of credit, which are often tied to prime rates that are compared to the Fed rate, even if higher inflation pushes rates on long-term home loans up.
“We will be looking to achieve an average inflation of 2% over time,” said Powell in his Jackson Hole speech. “Therefore, after periods when inflation has been below 2%, an appropriate monetary policy will likely aim to keep inflation slightly above 2% for some time.”
The policy will only come into play when the US economy has recovered enough to push up prices. That won’t happen until the pandemic is brought under control, Powell said last month.
For decades, the Fed hiked rates as unemployment fell to keep the economy from overheating. The central bank used this approach from 2015 to 2018, raising rates nine times as the unemployment rate fell, trying to stop inflation before it materialized.
Over the past 12 months, the US unemployment rate rate fell to an all-time high of 3.5% without triggering inflation.
When asked during testimony in Congress last year what happened, Powell simply replied, “We were wrong.”