Opinion: Can Mortgage Rates Avoid a Taper Tantrum As Fed Exits Market?

It’s a dicey time for mortgage rates as the Federal Reserve signals the end of the massive bond-buying program it began last year to support the economy during the pandemic.

Fed policymakers are meeting in Washington D.C. on Tuesday and Wednesday, and Fed Chairman Jerome Powell will hold a press conference at the end to answer questions from reporters.

The last time the Fed exited the bond markets after an asset-purchase rescue program – and, it’s only happened one other time, in 2013 – the average U.S. rate for a 30-year fixed mortgage spiked more than a percentage point as traders worried the world would come to an end.

Back then, Wall Street called it the taper tantrum. This time, it looks like the bond markets are blissed-out, with the benchmark 10-year Treasury yield drifting downward in the week before the central bank meets. The average rate for a 30-year fixed mortgage, which tends to track long-bond yields, also has fallen.

That means there's lots of pressure on Fed Chairman Jerome Powell to get through the week without freaking out the multi-trillion-dollar bond markets.

We already know what the Fed will be buying in the upcoming weeks. The market specialists who enact the Fed's orders from their offices in the Federal Reserve Bank of New York's building in lower Manhattan have posted their plans for all to see, covering asset purchases through mid-July.

Bond traders, of course, base their strategies on expectations for the future, not present realities, so any hint that the taper predicted for the second half of 2021 will be bigger or faster than expected will send the market into a tizzy.

At the last meeting of the central bank, in April, the Fed reiterated its commitment to “continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the committee’s maximum employment and price stability goals.”

That’s the language that likely will be tweaked at this week's Fed meeting. And, Powell surely is expected to be questioned about it by reporters on Wednesday afternoon.

Since becoming head of the world's largest central bank in 2018, Powell has learned that a stray word at a press conference can send markets into gyrations around the world. While he prides himself on being a plain-speaking economist, he has learned to express himself in the more guarded ways that Fed chairmen are known for.

So far, bond traders have let themselves be reassured by the Fed's message that while inflation will spike in the short-term, based on year-ago comparisons to months that had pandemic lockdowns, it will level off over time. On Thursday, government data showed consumer prices jumped 5% in May from a year ago, the largest annual increase since 2008. By the close of business on Friday, the average rate for a 30-year fixed mortgage had dropped to 3.12% from 3.14% on Wednesday, the day before the inflation report, according to Optimal Blue data.

Even Larry Summers, the former Treasury Secretary, admitted on Bloomberg Television's "Wall Street Week" on Friday that he's baffled by the direction of yields, which dictate the direction of mortgage rates.

“I’m surprised," he said. "I would have expected that yields would have risen more.”

Regardless of short-term reactions to Fed taper plans, mortgage rates are expected to remain low in the long term. Fannie Mae, the world's largest mortgage buyer, says the average U.S. rate for a 30-year fixed mortgage likely will be 3% in 2021 and 3.4% in 2022.

In 2013, after the taper tantrum sent mortgage rates spiking at the dizzying pace of more than a percentage point in two months, the Fed walked back its plans to wind down asset purchases. It didn't start scaling back until the following year.

What the markets do this time, and how the Fed reacts, will all play out in the coming weeks.