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Thinking of Refinancing Before the Fed Resumes Hiking Rates?

April 20, 2016
Refinancing your home? Think twice if your primary reason is Fed interest rate policy

When the U.S. Federal Reserve hiked interest rates in December for the first time since 2006, it seemed that mortgage rates would likely rise over the coming months. The Fed had projected four rate hikes in 2016, and traditionally, higher interest rates lead to higher mortgage rates.

Surprisingly, however, 30-year mortgage rates were lower by late March than when the Fed made its move. Rates fell to an average of 3.73%, compared with 3.97% in mid-December, according to the Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac (see figure 1). Mortgage rates came under pressure early this year as the stock market and oil prices fell sharply, accompanied by widespread concerns about possible global recession. Those concerns faded as March moved along, but overseas economies remained weak, and U.S. interest rates haven’t come even close to testing 2015 highs. Now the Fed says only two rate hikes will occur this year.

So does this mean homeowners can wait longer to refinance? Or will recent strength in the economy, as tracked by various economic data released since mid-February, put pressure on the Fed to increase rates more quickly, meaning homeowners might be seeing the last of these very low mortgage rates?

Mortgage rates from Freddie Mac


The rate for 30-year mortgages fell from nearly 4% at the start of 2016 to 3.73% by late March, despite the Fed’s December interest rate hike. Data and image source: Freddie Mac. For illustrative purposes only. Past performance does not guarantee future results.

Mortgage Rates Remain Low, but Fed Is the Wild Card

At least for now, some say it seems that there’s no need to hurry and refinance, although mortgage rates may rise modestly in the next year or two. In a recent analysis, Freddie Mac noted the U.S. housing market was one of the “few bright spots” of the economy last year, and it expects continued improvement in 2016. Still, it predicts “persistently low” mortgage rates, which it says could lead to additional refinancing. The Mortgage Bankers Association (MBA) predicts 30-year mortgage rates to average 4.1% in 2016 and 4.7% in 2017, both still relatively low by historical terms and not far above current levels.

But Freddie Mac noted that if the Fed becomes more hawkish, refinancing could diminish. The Fed’s next two policy meetings take place later this month and in mid-June. In mid-March, the Fed decided to leave rates flat. Later in March, a number of Fed officials, including Atlanta Fed President Dennis Lockhart, began talking about the possibility of an April or June hike.

It’s economics 101 that in a rising rate environment, mortgage rates also tend to rise. That has been the pattern historically, as seen in figure 2. In the early 1980s, as the Fed dialed up interest rates to record highs in an attempt to snuff out persistent inflation, mortgage rates soared. To a lesser extent, rates climbed in the late 1990s as the Fed hiked rates in a strong economy.

30-year mortgages and Fed interest rates


In periods when the Fed raised interest rates, as in the late 1970s and the late 1990s, mortgage rates rose, too. Data source: Board of Governors of the Federal Reserve System. Image source: For illustrative purposes only. Past performance does not guarantee future results.

Cautious Fed Stance Tempers Rising Rate Worries

Although it’s tempting to run and refinance when the Fed starts talking rate hikes, it’s worth noting that rates today remain below 4% and aren’t expected to go much higher in the next year or so. The failure of last December’s rate hike to do anything to mortgage rates also suggests that future Fed rate hikes may not have a huge impact. And the Fed isn’t talking about any aggressive changes in policy, particularly with overseas markets still dragging.

The Fed’s cautious stance is evident in a March speech by Fed Governor Lael Brainard. “First, we should not take the strength in the U.S. labor market and consumption for granted,” Brainard said. “Given weak and decelerating foreign demand, it is critical to carefully protect and preserve the progress we have made here at home through prudent adjustments to the policy path. Tighter financial conditions and softer inflation expectations may pose risks to the downside for inflation and domestic activity. From a risk management perspective, this argues for patience as the outlook becomes clearer.”

That doesn’t sound like a 1970s or 1990s scenario, when rate hikes were persistent and interest rates rose to high levels to protect the economy from inflation. Brainard noted that inflation as monitored by the Fed has been stuck in the 1.25% to 1.5% region since 2012. The Fed’s target inflation rate is 2%.

The fact that mortgage rates actually headed lower after the Fed’s December rate hike, along with an accompanying decline in U.S. 10-year Treasury yields to well below 2%, demonstrates that the Fed’s plan to raise rates further isn’t spooking the market much.

How Can Investors Benefit From Low Mortgage Rates?

Even investors who don’t care to refinance can find ways to participate in what they see as a current strong housing market and low mortgage rates. Home-related stocks were strong performers in 2015 as rates stayed low, and some analysts remain optimistic about the sector going forward. Housing starts continued to rise, with the February figure up 31% year over year.

“We have a positive fundamental outlook for the homebuilding sub-industry for the next 12 months,” wrote Erik Oja, banking and homebuilding analyst for S&P Global Market Intelligence, in a recent note to investors. “Based on recent housing starts, sales of existing homes, and prices of existing homes, we think the U.S. housing industry is in recovery mode.”

Indeed, housing starts could serve as a good canary in the coal mine for the economy as a whole, said Sam Stovall, U.S. equity strategist at S&P Global Market Intelligence.

“Housing starts may be a good indicator of economic growth, not because of the importance of construction to the U.S. economy, but because of its reflection of consumer confidence,” Stovall wrote in a recent note to investors. “Consumers are not going to buy a home if they feel uncertain about the outlook for the economy.” 

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