The Federal Reserve revealed an unsettling truth by leaving the federal funds rate unchanged, according to Bob Walters, chief economist at Quicken Loans.
“I think that they find themselves between a rock and a hard place,” Walters says.
The Fed is caught between two significant economic threats that require contrary responses, Walters says.
On one hand, the Fed is concerned that raising rates could tip a weak economy into recession.
“They know that the credit crunch continues, and that the economy is slowing and that providing stimulus to the economy and the banking system is what would assist in that,” he says.
On the other hand, the central bank worries that keeping rates low may increase inflationary pressures already building in the economy.
“They certainly see what’s happening with prices,” Walters says. “They know the best way to deal with that is to raise rates and decrease liquidity to the economy.
“So, they are in a bit of a box.”
Walters believes the Fed will raise rates at some point to keep inflation contained. For now, the central bank is signaling it is more worried about other threats to the economy, he says.
“We as a country are struggling right now, with the housing market and with the credit markets,” he says. “I think that the Fed is just going to be biased to keeping liquidity in the economy, and maybe willing to accept a little more inflation pressure than they normally would.”
Richard DeKaser, chief economist for National City Corp., paints a similar picture.
In recent weeks, many people have been surprised by the relative strength of the economy, he says. Metrics such as
commercial paper and credit spreads for asset-backed paper have “improved to reasonable levels,” DeKaser says.
“The economy has outperformed the pessimists’ view, which was the consensus view,” he says.
Despite such positive signals, DeKaser says threats to the economy clearly “have not been fully vanquished.
“The financial market improvement since March has been substantial but — I would argue — also incomplete and tentative,” he says.
Because core inflation remains “relatively benign,” the Fed has “enough time to simply wait for more evidence to roll in” before raising rates, DeKaser says.
The direction of mortgage rates
In recent weeks, mortgage rates have climbed steadily. DeKaser believes this trend reflects a stronger-than-expected economy and corresponding market anticipation of a Fed rate hike in late summer or early fall.
However, he says downside risks to the economy and financial markets make such increases unlikely for now. If rate hikes fail to materialize by fall, mortgage rates may begin to slip, he says.
“I wouldn’t be surprised if at some point we see long-term rates diminish somewhat as the pricing in of a hasty Fed rate hike is discounted,” DeKaser says.
However, over the longer haul, DeKaser expects mortgage rates to rise after the Fed inevitably begins to tighten. He’s forecasting 30-year-fixed rates to grow from 6.25 percent to 6.75 percent over the next year.
“The longer-term trend over the next 12 months will be upward,” he says.
Walters also suspects that mortgage rates will rise, but doesn’t expect the increase to be especially pronounced.
“A year from now, I don’t know that interest rates will be substantially higher than they are today for mortgages,” he says.
He adds that rates also are unlikely to fall significantly unless “the economy really went into a rough patch,” a scenario he does not expect to materialize.
“I absolutely don’t see a doomsday scenario,” he says. “People who say that, I think they underestimate the flexibility and just the pure productivity and creativity of our economy. It’s not a one-dimensional economy.”
What you should do
Homebuyers and homeowners looking for a new mortgage need to navigate this uncertain market carefully, Walters says.
Now that credit conditions are tighter, it’s more important than ever to find an experienced, credible lender, he says.
“This is probably a time where the value of the information and the expertise that you get is more important than it has been in the past,” Walters says.
Choosing a lender who has the right loans and products available “may mean the difference between you getting the house or not getting the house,” Walters says.
For many borrowers, that means working with a larger lending institution, Walters says. He urges borrowers to avoid lenders who contact them through cold calls and direct mail. Instead, stick with known quantities.
“Ask friends for referrals,” Walters says. “I think that’s important.”
Walters also urges people to work with lenders who have access to loans from the Federal Housing Administration, or FHA.
Now that options such as subprime loans and higher loan-to-value programs have disappeared, FHA loans are the only game in town for people with bruised credit, smaller down payments or other financial problems, Walters says.
“There’s a huge vacuum left for people in that category, and we’re not talking about a small number of people — we’re talking about millions and millions of people,” he says. “Had the FHA not stepped up, they simply would not have been able to get a mortgage.”
For DeKaser, there are a couple of “no-brainers” for borrowers who fit certain profiles.
First, he says, borrowers should refinance immediately if they have a loan that will reset soon to a much higher rate.
“For people who are confronting dramatic rate resets under previous teaser programs that are going to take them above long-term mortgage rates now, seize the moment by all means,” he says.
Second, he urges homeowners with more stable mortgages not to rush into a refinance simply because they fear mortgage rates might go higher.
“I don’t think the change in rates is likely to be that dramatic,” he says. “So, I wouldn’t encourage anyone paying up, for example, for a rate reset to lock in a quarter-point savings or something.
Most experts expected the Federal Reserve to hold interest rates steady, and the central bank did not disappoint. However, it remains unclear what the Fed’s next move will be.
In the meantime, experts urge borrowers with risky mortgages to refinance now. You can use Bankrate’s
mortgage rate tables to find the best rates on a