The tapering of asset purchases by the U.S. Federal Reserve seems imminent. Investors and economists around the world have indicated that a decision to reduce the number of mortgage-backed securities and longer-term Treasury securities being purchased by the Fed — currently at $85 billion each month — could be made as early as September, when the Federal Open Market Committee is next scheduled to meet.
The specter of this decision has hung heavily over the markets for months. Quantitative easing — the introduction of new money into the market — has four primary effects on the economy, including higher inflation expectations, currency depreciation, higher equity valuations, and lower real interest rates.
Or, to put it another way, QE changes the parameters under which the market operates. The Fed, acting in good faith in an attempt to stimulate business activity, effectively reduced the cost of money. This easy-money policy encouraged businesses and individuals to borrow and spend, behavior that may be most evident in the recovery of the housing market following its collapse during the financial crisis.
With the benchmark federal funds rate already trapped at the zero bound, the QE drove longer-term interest rates such as the rate on mortgage loans down to record lows. These low rates enticed people to either refinance an existing loan or compelled them to take action and take out a new loan.
The housing market has been hailed as a beacon of the economic recovery in the United States and much of the credit can fall to record low interest rates on mortgages. Home prices and sales have both recovered dramatically since the crisis. The latest Federal Housing Finance Agency report showed that home prices continued their relentless climb higher in the second quarter, increasing a seasonally adjusted 0.7 percent on the month in June, its 17th consecutive increase.
The FHFA home price index for the U.S. in June is roughly at the same place it was in February 2005. Home prices have increased at an annually compounded rate of 3.0 percent since January 2000, and 3.2 percent since January 1991.
At a glance, this is all tremendously positive news. Millions of homes are emerging from underwater mortgages as prices increase, and sales and new construction has helped stimulate economic activity. However, like with all rallies, this one is bound to run out of steam, and rising mortgage rates are the first sign of the slowdown.
The Mortgage Bankers Association reported that new loan applications dropped a seasonally adjusted 4.6 percent on the week for the period ended August 16. This makes 13 declines over the past 15-week period. It should come as no surprise that over this same period, the average commitment rate on a 30-year fixed-rate mortgage has increased, reducing demand for the loans.
The dramatic increase in mortgage rates itself wasn’t entirely unexpected either. The rates were driven lower due to the Fed’s monetary stimulus program, and now that speculation about tapering is rampant, interest rates have come up across the board. The interest rate on the benchmark 10-year U.S. Treasury has increased 45 percent over the past six months.
The increase in mortgage rates has decreased loan activity, and as a result, financial institutions involved in the business have taken a blow. Wells Fargo (NYSE:WFC) — the largest employer in the U.S. financial industry, and the bank that was responsible for as many as one in three home loans in 2012 — is reportedly laying off 20 percent of its 11,406 mortgage loan officers because of the evaporation of demand.
The news follows similar announcements from financial institutions like JPMorgan (NYSE:JPM), which announced in February that it was going to lay off as many as 17,000 people in the U.S., most of them from its mortgage business. Bank of America (NYSE:BAC), which previously targeted restructuring and cost-savings layoffs of up to 30,000 people, has also made large reductions to its mortgage workforce.
Overall financial services employment fell significantly during the crisis from nearly 8.4 million to just under 7.7 million before headcount began to increase again.
Here’s how the main U.S. indexes traded on Friday: