The two-day Federal Open Market Committee (FOMC) meeting that starts today and ends tomorrow is very important because it's the first meeting of the year, and it's the first since the Dec. 11-12 meeting last year when a new round of quantitative easing was announced.
The minutes of the December meeting, released about three weeks ago, spooked the markets and were the primary catalyst for treasury yields to increase since then. The fact that more than half of the Federal Reserve governors and presidents expressed concerns about continuing QE3 (buying mortgages, announced in September), and QE4 (buying treasuries, announced in December), has shaken bond market participants.
It's not the only issue driving Treasury yields, which have been rising since July when the 10-year note hit a closing-low yield of 1.43%. Between then and the December FOMC meeting, though, the yield only rose about 23 basis points to 1.66%. Since that meeting just six weeks ago, the 10-year yield has risen another 29 basis points to 1.95% today, which is off from its high yesterday of 1.99%.
From an economic standpoint, the reason this is so important is that many loan rates are tied to the yield on the 10-year Treasury, especially mortgage rates. Housing is the engine of the economy. It's the primary indicator of substantive confidence and consumption. The par 30-year-fixed-mortgage rate over the past six weeks has risen even more than the 10-year Treasury yield, by about 0.375% to about 3.75% today. The primary reason for QE3 and QE4 is to drive mortgage rates down to stimulate housing activity.
There are multiple other reasons for yields to be rising now. Seasonally, yields rise in the first quarter; it happened in 2010, 2011 and 2012. The opposite occurred in 2009, though (I'll come back to that shortly).
The beginning of repayment of Long-Term Refinancing Operations (LTRO) by European banks has many of them selling U.S. Treasuries to repatriate the funds to pay back the ECB, too. Market participants increasingly reflect optimism about the economy, and there are signs that retail investors are shifting from the cash positions they've maintained since the 2008 financial crisis.
Most important is the fact that in the aftermath of the release of the December FOMC minutes, Fed Chairman Ben Bernanke has been quiet, and the sound of his silence has been deafening to bond market participants. This is leading to rampant speculation by pundits about the conviction the Fed has about QE3 and QE4, and the chair's control of the FOMC. With Bernanke's term expiring in a year, market participants are concerned about his replacement and whether the new chief will have the same dovish outlook on inflation that Bernanke has increasingly exhibited.
Because of this, the statement released after this week's FOMC meeting is very important to the bond market, all loans tied to Treasury yields and economic activity in 2013. The market wants to see a reiteration of the commitment to QE3 and QE4 with stronger language than last month because of the shaken confidence since then. They market probably won't get it. If the statement appears to validate a shift toward a more hawkish Fed, expectations of the Fed terminating QE3 and QE4 earlier than 2014 will be the result. Instead of yields declining into the spring and summer, they could follow the 2009 path, when the 10-year Treasury yield opened at 2.46%, rose steadily to 3.98% on June 10 and closed the year at 3.85%. This caused mortgage rates to jump 150 basis points into the spring and summer and snuffed the critically important housing recovery. If the FOMC statement this week is weak, a replay of 2009 bond yields may occur.
Although that would certainly end the mortgage refinance boom that has supported the big banks' fee income over the past few years, its impact on the home purchase market is questionable. An increase of mortgage rates from 3.25% in December to 4.25% this spring could be the catalyst to ignite an increase in purchases as consumers attempt to get ahead of the rising costs of debt capital. Or it could kill the nascent housing recovery, as it did in 2009.