Will Mortgage Rates Rise When the Fed MBS Program Ends?

There's been a lot of discussion on financial sites about whether mortgage rates are going to rise once the Fed stops purchasing mortgage backed securities. The general consensus is that it they will, although not as much as people might expect. Tonight, I found a really good article that explains the forces in play that will push rates up and also help to moderate them.

In his article entitled Fed's Exit from MBS Program on Course as Planned, Adam Quinones from Mortgage News Daily provides a pretty good examination of what's going to happen. According to him, there are three forces that will impact mortgage rates:

1. The direction and movement of benchmark Treasury yields
2. The perception of risk in holding mortgage-backed securities as an investment (loss of principal investment)
3. Supply and Demand in the agency MBS market

He sees Treasury yields rising modestly over the next three months. This seems a relatively safe bet, unless there are more sovereign default scares and investors continue to stash cash into safe-haven Treasuries.

The perception of risk is a factor of the jobs market and the overall economy. If the job market improves, then risk goes down as default rates slow. If the economy continues to plod along, then risk does not decrease. At the moment, the Fed has been purchasing MBS's almost regadless of risk. Third party investors will surely demand more return in order to take on the same risk and that will cause mortgage rates to rise.

The third part of his equation is loan demand. He writes:

"Since refinance activity peaked in mid-2009, we have observed a progressive slowdown in loan production. More originators are dropping out of the industry while others continue to fight for every loan application. While we have been communicating this observation since late summer, we need the MBA to provide some "official" backing to our outlook. Michael Fratantoni, MBA's VP of Research and Economics, summed up the mortgage environment PERFECTLY:

'Although rates remain low, there appears to be a smaller pool of borrowers who are willing and able to refinance at today's rates.'"

This will decrease the supply of MBS on the market and help to put a roof on rate increases.

So, put it all together:

"There will be demand for agency MBS when the Fed exits the secondary mortgage market. However, investors will likely let MBS valuations cheapen up before becoming buyers again. This will force mortgage rates higher. It is inevitable. In regards to the question "HOW MUCH DO THEY RISE". MNDs (Mortgage News Dailys) inner circle believes the spike won't be as sharp as many anticipate (relative to benchmark Treasuries that is). If the 10 year Treasury note moves as far as 4.00%, we estimate the par 30 year fixed mortgage rate will move as high as 5.50%."

So there you have a glance at how those far more in the know that I are projecting the rise in interest rates. They take projected Treasury yields and then add some factors based on supply and demand.