It’s official: the bond taper is here, according to the November 2021 Federal Open Market Committee (FOMC) statement.

Under this bond taper, the Federal Reserve (the Fed) will begin to reduce its bond purchases by $15 billion a month, $5 billion of which will be a reduction in the purchase of mortgage-backed bonds (MBBs). For reference, this $15 billion per-month reduction follows months of $120 billion in bond market purchases per month.

Beginning in March 2020, the Fed began buying MBBs, thereby reducing their supply. Simply put, a reduced bond supply means higher prices. Due to the inverse relationship between interest rates and prices, the higher prices induced by the Fed’s MBB purchases have resulted in lower yields, or lower interest rates.

MBB purchases are a helpful Fed tool to stimulate the economy during fragile economic times, as lower interest rates and a higher money supply encourage consumers to take out loans, and banks to lend. This includes auto loans, personal loans and, yes, mortgage loans. These lower interest rates have supported home sales volume, refinances and home values during the pandemic-charged recession and our ongoing recessionary hangover.

Interest rates to rise

Mortgage interest rates recently hit an all-time low at the beginning of 2021. While they have increased slightly throughout 2021, interest rates still remain near these historic lows heading into 2022.

While the Fed is beginning to reduce their bond purchases in November 2021, they are not yet ready to increase their benchmark interest rate, the Federal Funds Rate. The Fed has indicated it intends to keep this rate low through 2023, though bond market participants are less certain. In fact, many investors believe the Fed will boost their benchmark rate as soon as mid-2022, according to the New York Times.

When the Fed does allow this rate to inch higher, borrowing will become more expensive for individuals and businesses, and the effect on mortgage interest rates will be immediate.

The Fed is now attempting to balance 2021’s high levels of inflation and housing prices with the still-wounded jobs market.

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Super-charged inflation has the Fed re-thinking their interest rate strategy

Here in California, there are still more than 1 million jobs missing from the employment market compared to the pre-recession peak. When borrowing becomes more expensive, the ripple effect will slow hiring, throwing up a needless roadblock to recovery. Thus, the Fed is pulling back some of its support, but not all.

In other words, it’s important to remember that while the Fed is beginning its bond taper, they are still purchasing bonds each month (just lower amounts), and they are still providing support for the mortgage market.

Thus, don’t panic, and don’t expect interest rates to jump overnight, though they will likely continue to rise slowly. There is a reason the Fed calls it a taper and not a complete halt to purchases — the Fed will gradually remove its support in hopes the bond market will have legs to stand on its own when the Fed finally reaches an end to its purchases.

Stay tuned to firsttuesday as the Fed continues their economic balancing act and watch the impacts to California’s housing market emerge.