The Federal Reserve didn't tip its cards on raising interest rates. At least, not in its prepared post-meeting statement. The message continues to be that a "highly accommodative stance of monetary policy" will remain in place until unemployment dips below 6.5% or inflation expectations start tipping above 2.5%. It's the same heavy dose of non-clear clarity that's been driving markets crazy for some time now.
But if you're a potential home buyer who's had a close eye on mortgage rates, or an investor in mortgage- and interest-rate sensitive businesses like banks and mortgage REITs, there's plenty that the Fed has offered that hints at timing.
If we look to the supplemental release of the Fed's economic projections, we can see the "central tendency" projection for unemployment has come down for both 2013 and 2014.
The low end of the range suggests we could be looking at unemployment hitting the magic 6.5% level in 2014. Based on the "range" projections -- which include the high and low outliers -- unemployment could go even lower. Meanwhile, neither total nor core PCE inflation is seen getting anywhere near 2.5%.
In other words, if the optimistic end of those estimates are on point, we could be hearing the Fed talking about adjusting its Fed Funds target rate some time next year. Based on the chart below, most Open Market Committee participants don't think the change will occur next year, but it's clear the key rate is expected to start moving in the 2014-2015 range.
But it's not just the Fed Funds rate we need to focus on. The Fed also has a significant asset purchase program going on -- to the tune of $40 billion in the agency mortgage-backed security market, and $45 billion in the Treasury market. As the Fed contemplates unraveling accommodation in light of stronger economic performance, those programs will almost certainly be shut down before the Fed Funds rate is touched.
As noted above, this is well worth paying attention to if you're in the market for a mortgage. It's also notable if you're a major mortgage originator like Wells Fargo (NYSE: WFC ) and JPMorgan (NYSE: JPM ) -- the two U.S. origination leaders. And it's notable as well if -- like mortgage REIT giants Annaly Capital (NYSE: NLY ) and American Capital Agency (NASDAQ: AGNC ) -- your primary business is investing in agency mortgage-backed securities.
Higher rates are a mixed blessing for the likes of Wells and JPMorgan. Rising rates blunt the refinance activity that's provided a nice dose of fee income in recent quarters. But higher rates could also lead to larger spreads between what the banks lend money for and what they pay to borrow it. Over the longer term, higher rates could also benefit the mREITs, but the short-term hit to portfolio values -- higher rates reduce the value of currently held securities -- could be painful.
Luckily, the message here is a simple one: Rates are on their way up. For the Wallstreetiest of the Wall Streeters, 12 to 24 months is mind-numbingly long term. For the rest of us, it's really not that long at all. And it's over that time frame we're going to see a continuation of the recent higher-rate trend. It won't be short-term (days, weeks, or months) predicable, and it won't be smooth and steady. But it sure looks like -- after years of bold calls that higher rates were just around the corner -- it is indeed happening.
And Fed economic projections aside, it's not a mystery why it's happening, either. Unemployment declined from 8.2% in May of 2012 to 7.6% in May of this year. And it's well off of the double-digit levels we saw just a couple of years ago. In the first quarter, consumer spending was up 3.3% from the prior year. It's up 7.6% over the past two years. First-quarter nominal GDP was up 3.4% from the prior year. And that's even as federal and state government spending continues to be a drag on growth.
In short, the Federal Reserve has been providing serious "accommodation" in an effort to aid the economic recovery. The recovery hasn't been fast or showy, but it's happening, and market participants are anticipating the logical next step.
In response, freaking out is certainly one option. Perhaps a better one is soberly considering what exactly higher rates will mean for your bottom line.
Can you still buy Annaly?
There's no question Annaly Capital's double-digit dividend is eye-catching. But can investors count on that payout sticking around? With the Federal Reserve keeping interest rates at historically low levels, Annaly has had to scramble to defend its bottom line. In The Motley Fool's premium research report on Annaly, senior analysts Ilan Moscovitz and Matt Koppenheffer uncover the key challenges the company faces and divulge three reasons investors may consider buying it. Simply click here now to claim your copy today!