News of a Cyprus bank bailout proposal caused a flight to safety early in the week which helped mortgage rates. Investors then viewed the Fed statement released on Wednesday was negative for mortgage rates. These two factors roughly offset each other, and mortgage rates ended the week just slightly lower.
The banks in Cyprus, a member of the European Union, are in dire need of additional capital. Cyprus is a tax haven for foreigners and its banking sector is enormous compared to the size of its economy. The EU proposed to loan Cyprus some of the needed funds, if Cyprus raised the rest through a one-time tax on all bank deposits. The bank deposit tax was very unpopular, and government leaders in Cyprus voted against the bailout plan without providing an alternative. EU officials warned that they will cut off emergency funding for banks in Cyprus on Monday, (Today), if Cyprus is not able to come up with the rest of the needed funds. Most analysts view the Cyprus bailout terms as a unique situation given its nature as a tax haven, but investors are nervous that the troubles may spread.
The Fed statement did not contain any major surprises, but investors did receive a little more information on the Fed’s exit strategy from its current Treasury and MBS purchase program. When Fed officials are satisfied that there has been significant improvement in the labor market, they plan to gradually decrease the quantity of monthly purchases below the current level of $85 billion. Even if the Fed begins to tighten in baby steps, the question is how big a reaction there will be in MBS markets when the Fed announces that the time has come. Signs of the impact were seen on Wednesday when concern that the Fed may begin to scale back its MBS purchases sooner than expected caused mortgage rates to rise.
Looking ahead, investors will be watching to see how Cyprus will deal with its financial troubles. In the US, it will be a busy week for economic data. Durable Orders and New Home Sales will be released on Tuesday. Pending Home Sales will come out on Wednesday. Chicago PMI and Final GDP will be released on Thursday. Core PCE inflation and Personal Income are scheduled for Friday. In addition, there will be Treasury auctions on Tuesday, Wednesday, and Thursday.
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