Bernanke, Fed say no taper. Will housing bounce?

The Federal Reserve's surprise announcement that it would not taper its economic stimulus program this month is rattling through world markets: the US stock market surged into record territory, gold rose sharply, and interest rates on US Treasury securities fell.

But one of the biggest and direct impacts could be on the housing market. Wednesday's unexpected move – actually, the lack of a move – could cause mortgage rates to fall and give a boost to housing. The rate on the Treasury's 10-year note – a bellwether for mortgage rates – fell sharply after the Fed announcement. At 3:45 p.m, the rate had fallen 15 basis points to 2.71 percent. It had been as high as 2.98 percent earlier this month.  

Rising interest rates were a key factor in the decision by the Fed's Federal Open Market Committee, which sets short-term interest rates.

"The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction," the Fed announcement read. "Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."

The Fed's securities purchases – particularly its purchases of $40 million of mortgage-backed securities every month – drove mortgage rates to record lows last year, which helped kickstart a recovery in the housing sector by boosting sales and, subsequently, home prices. Mortgage rates bottomed out at 3.31 percent this past November, and sales of existing homes have risen 17 percent since last year. In June, home prices increased 12.1 percent above the level seen in June 2012, according to the Case-Shiller home price index.

The worry was that a pullback on Fed purchases (and the subsequent increase in interest rates), might slow the housing recovery before it became truly sustainable. Indeed, talk of tapering has already had an effect: Since Fed Chairman Ben Bernanke first mentioned the possibility of scaling back the Fed’s purchases this past June, the average rate for a 30-year fixed rate mortgage has surged over 100 basis points –sitting at 4.6 percent as of last week – and certain market indicators are showing signs of slowdown. Mortgage applications, in particular, have fallen in recent weeks.

“We’ve seen a pretty big jump in rates given the fact that there is no actual change in monetary policy and not much change elsewhere [in the economy],” says David Berson, chief economist at insurance provider Nationwide and former chief economist at mortgage lending giant Fannie Mae. When it comes to buoying interest rates, “you can’t point to much else” besides speculation about the tapering, he says.

But the announcement that purchases will continue as before will likely have the opposite effect: mortgage rates could go down. Mr. Berson and other analysts has already predicted that the impact of tapering would have been modest, if felt at all, for two reasons. First, most of the purchase loss (between $10 billion and $15 billion predicted) was expected to come from its purchases of Treasury bonds, rather than the mortgage-backed securities. Second, the mortgage market has already accounted for some purchase cutbacks with the rise in interest rates. In fact, even before the afternoon's surprise, some economists were guessing that rates would inch down a bit.

But the longer-term effects, Mr. Berson notes, are more difficult to guess, because this housing recovery is unlike any that have come before.

“Usually housing, because it’s so rate-sensitive, it tends to recover first,” he says. The pickup in existing homes has previously been followed closely by new construction and jobs, but this time,  “housing starts haven’t picked up that much. The overall impact has been muted because there were still large numbers of vacant homes. So we haven’t had the pickup on the construction side that we would normally see. There has been a pickup, but a more normal recovery would have seen housing starts pick up more.”

Housing starts rose 0.9 percent in June, below analysts’ forecasts, but the single-family segment of the report was better than expected. 

In a press conference, Mr. Bernanke left open the possibility that the Fed could begin tapering later this year.

"Conditions in the job market today are still far from what all of us would like to see," he said. Not reducing the stimulus was "a precautionary step."