We have been hearing a lot from the Federal Reserve over the past few months. Starting with an emergency meeting on a Sunday night in mid-March where Fed Chairman Jerome Powell cut overnight-banking rates to zero and launched a massive $700 billion quantitative easing program. This unprecedented move was followed with additional efforts over the next few weeks and months by expanding their bond-buying programs well beyond historical proportions. Some call them the heroes of this pandemic, while others challenge the long term horrific impacts of their actions.
To say the Fed is in unchartered territory is an understatement. Before I write about an entirely new chapter in the life of the Fed, I thought it would be helpful to learn more about this organization. The Federal Reserve, the central bank of the United States, was created to accomplish five general functions to promote the U.S. economy’s effective operation. Per their homepage, The Federal Reserve conducts the nation’s monetary policy to foster maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy; promotes the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad; promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole; fosters payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and promotes consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.
Since 1977, the Federal Reserve has essentially operated under what is commonly referred to as a “dual mandate” from Congress - to “promote the goals of maximum employment effectively and to stabilize priced for goods and services by moderating long term interest rates.” So how does the Fed typically accomplish their mission? The first way is to stimulate a weak economy by making it easier to borrow money; this is typically when interest rates are lowered; the second is to keep the economy from overheating, which causes inflation to spike upward. When inflation is high, interest rates are raised to cool the economy.
On August 27, 2020, the Fed delivered a ‘profoundly consequential’ speech, changing how it views inflation. Fed Chairman Jerome Powell announced a significant policy shift to what is called “average inflation targeting.” That means the central bank will be more inclined to allow inflation to run higher than their standard “2% target” before hiking interest rates. As anyone who reads my articles knows, mortgage rates are hurt by inflation. With inflation, when prices rise over a period of time, it reduces the buying power of the dollar. When inflation is high, the income earned by bond investors has less value because its purchasing power has been reduced. Therefore, fixed-rate bonds tend to be less appealing to investors during periods of high inflation. A decline in bond demand creates a drop in bond prices. Bond “yield” reflects the price and the stated interest rate on the bond; thus, a decline in its price leads to an increase in its yield.
So what does this mean to the average consumer? If the Fed does allow inflation to drift higher, things will start to cost more without any additional benefit or value. As rates increase, homes become less affordable, debt becomes more costly, and life becomes more expensive. That’s not to say this is something that should be expected overnight – in fact, I am sure the Fed would love to see a spike in inflation, which is now still below 1%. The bottom line is that the Fed is doing everything in its power to try to jump-start the rise of inflation, even letting Americans know that they will tolerate higher levels of it. In the meantime, lock your low rate mortgage before their wish does, in fact, come true. Shout out and happy birthday to Nina Eizikovitz, Dov Goldman, Donny Kanovsky, and Sivan Krug.
Shmuel Shayowitz (NMLS#19871) is President and Chief Lending Officer at Approved Funding, a privately held local mortgage banker and direct lender. Approved Funding is a mortgage company offering competitive interest rates as well as specialty niche programs on all types of Residential and Commercial properties. Shmuel has over 20 years of industry experience, including licenses and certifications as a certified mortgage underwriter, residential review appraiser, licensed real estate agent, and direct FHA specialized underwriter. He can be reached via email at [email protected]