With little progress on the fiscal cliff talks and few surprises in last week’s economic data, the Fed meeting was the week’s big story. Policy changes announced in Wednesday’s Fed statement raised investor concerns about higher future inflation, and resulted in mortgage rates ending the week a little higher.
The Fed announcement contained two major policy changes. The first, which was widely expected, is that the Fed will purchase $45 billion per month of long-term Treasury securities beginning at the start of 2013 to replace the Operation Twist program which expires at the end of this year. This will be in addition to the $40 billion of mortgage-backed securities (MBS) that the Fed now purchases monthly. The second change from the Fed was not expected. For the first time, the Fed announced that it will keep the fed funds rate at very low levels until certain economic targets are reached. Specifically, the fed funds rate will remain low until unemployment falls below 6.5% and inflation tops 2.5%.
Despite four years of extraordinary levels of Fed stimulus, the economic data released last week revealed that inflation is not a problem right now. The week’s data showed that Core CPI, the most widely followed measure of inflation, was only 1.9%. The concern for investors after the Fed statement is that the Fed appears to be willing to tolerate a higher level of inflation in its efforts to boost the economy, and inflation is negative for mortgage rates.
This week, the fiscal cliff discussions will continue to dominate the US economic news. Beyond that, Housing Starts will be released on Wednesday. Existing Home Sales, Philly Fed, and the final revisions to third quarter GDP will come out on Thursday. Personal Income and Core PCE inflation will be released on Friday. Empire State, Consumer Sentiment, and Leading Indicators will round out the schedule. In addition, there will be Treasury auctions on Monday, Tuesday, and Wednesday.
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