Twist and Shout? Twist Again?

Everyone knows that the Federal Reserve is the nation’s central bank, and that The Fed sets monetary policy by adjusting the Federal Funds Rate. Lowering the rate (an “accommodative” policy) is supposed to stimulate the economy by making borrowing less expensive for the member banks. The Fed traditionally balances interest rates against the possibility of excessive inflation. If they believe the economy is growing too quickly (an inflationary tendency), they’ll raise the Federal Funds Rate, thereby slowing the growth rate.

So. With the economy definitely in the doldrums and the Federal Funds Rate now effectively at zero, what more can a poor Fed Chairman do?

He does “Quantitative Easing,” that’s what. This means the Federal Reserve participates directly in the market, buying things like Treasury bonds and (wait for it…) mortgage backed securities. The reason rates have been so low is that the Fed bought a ton of mortgages from Fannie and Freddie (“a ton” = $885 billion worth). This pushes the price of the security up, and the rate down. Amazingly down.

Economy? Still not so great. So Bernanke thinks to himself, “I’m not going to be able to write another close-to-a-trillion bucks check; Boehner, Cantor and those guys will hand me my head. But I still gotta do something.”

And so we have The Twist (cue the ’60s dance craze music). If I try and explain exactly how this works I know your eyes will glaze over, gentle reader, but in a nutshell, here’s what happened: The Fed owns a whole lot of government bonds, in different maturities. I mean a sh…er, boatload of this paper. The Twist involved selling $400 billion of short term (like 6 month and a year) bonds and using the money to buy longer term (10 and 30 year) bonds.

Yeah, I know…this is pretty compelling stuff.

But here’s where it starts to get interesting: Anyone who knows me at all knows that I am a geek when it comes to the movement of the mortgage market–specifically the Mortgage Backed Securities (MBS). When investors are buying the MBS, they go up in value, which pushes rates down. The MBS normally move about 25 ticks one way or the other during the business day. That moves mortgage rates about 1/16% from one day to the next.

Today, right after the announcement of The Twist at 2:20 PM EST, we saw the MBS soar almost 150 ticks. Look for mortgage rates to be quite a lot more amazing tomorrow morning.

Will this help the housing market, which is the key to the economic recovery? To be honest, I don’t really know. The answer to that question lies with those who want to buy homes, and with those who work with home buyers.

Yes, I am looking at you, Realtors and loan originators.


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