Fed's Influence on Mortgage Rates

Shifting expectations for the timing of the Fed's move to taper its bond purchases were the main influence on mortgage rates last week and caused extremely high levels of daily volatility. Stronger than expected economic data and comments from Fed officials caused investors to think that the Fed will begin to scale back its bond purchases sooner than previously expected. As a result, mortgage rates ended the week higher.

With a decline in the Fed's bond purchases in sight, and an improved outlook for global economic growth, investors have grown less willing to own bonds. Central bank bond buying helped bond yields decline to historically low levels. Following the financial crisis, investors accepted these low yields in order to receive the safety of government guaranteed fixed income securities. Over the course of this month, however, sentiment has shifted and investors are demanding higher yields to own mortgage-backed securities (MBS) and other bonds. Since mortgage rates are largely determined by MBS prices, mortgage rates have moved higher.

Historically, shifting inflation expectations have been the primary cause of changes in MBS prices and mortgage rates, but not this month. Normally, as inflation expectations rise, so do mortgage rates, and vice versa. In May, though, this relationship did not hold true. Inflation measures have been falling, yet rates have been rising. The April Core PCE price index released last week was just 1.1% higher than one year ago. Core PCE is the Fed's preferred inflation indicator, and it's far below the Fed's long-run inflation goal of 2.0%. The Core CPI inflation report released last week also showed declining levels on an annual basis. This shift from the fundamental relationship between mortgage rates and inflation shows the enormous influence the Fed has had on mortgage rates.