Amid surging COVID-19, Fed could take steps to lower mortgage rates, boost economy

As the Federal Reserve concludes a two-day meeting Wednesday, it will be struggling with how to respond to opposing forces in the nation’s COVID-19-fueled economic crisis.

On the one hand, a resurgence of the virus already has slowed the economy, and an even bleaker winter lies ahead. At the same time, wide availability of a vaccine by spring offers the prospect of a substantial improvement.

The Fed already has cut its key short-term interest rate near zero and vowed to keep it there until the economy returns to full employment and inflation runs above its 2% goal “for some time” – a promise that likely would mean no rate hikes until 2024 or beyond, some economists say.

But Fed officials still have more ammunition, largely related to their massive bond-buying stimulus aimed at holding down long-term rates that affect mortgages and other loans. The Fed’s policy decision, which will be released at 2 p.m. on Wednesday, is expected to center around those bond purchases – and it could mean slightly lower monthly costs for homebuyers and other borrowers.

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The central bank is also set to update its economic forecasts.

Here’s the breakdown of what the Fed may do:

How can the Fed cut long-term rates?

The Fed is now purchasing $80 billion in Treasury bonds and $40 billion in mortgage-backed securities each month, putting downward pressure on long-term interest rates, such as for mortgages and corporate bonds.  

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The average maturity of the securities it’s buying is 7.4 years, according to Oxford Economics. Some economists expect Fed officials to buy the same amount of bonds but shift the mix toward those with longer maturities. That would inject more stimulus into the economy by further pushing down rates for mortgages, corporate bonds and other types of loans.

Why shift bond purchases to cut rates?

COVID-19 is spiking across the country, with cases, hospitalizations and deaths reaching new records. That has led to new constraints on businesses, particularly in California and the Midwest. Job growth slowed sharply in November and initial jobless claims, a rough measure of layoffs, jumped sharply to 947,000 the week ending December 5.

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“The economy really needs,” more stimulus, says Oxford economist Kathy Bostjancic. 

“Fed officials might see the winter virus resurgence as the obvious moment to shoot their last bullet,” Goldman Sachs said in a research note.

Also, after a monthslong deadlock, Congress still hasn’t agreed on a proposed $908 billion relief package for unemployed Americans and struggling businesses. And Treasury Secretary Steven Mnuchin recently ended several Fed emergency lending programs, placing a greater burden on the Fed to prop up a wobbly economy, Bostjancic says.

What is the argument against taking more action?

Several regional Fed bank chiefs have said fiscal aid from Congress is what’s really needed right now. And lawmakers appear to be drawing closer to a deal before unemployment benefits for 12 million Americans, a ban on evictions and other programs expire at year’s end.

While such federal dollars can be doled out quickly, Fed maneuvers typically affect the longer-term outlook, three to six months down the road, says Nomura economist Lewis Alexander. By then, he notes, a vaccine is likely to be widely available, significantly bolstering the economy and lessening the need for more juice from the Fed.

What’s more, mortgage and other rates are already at historic lows, Capital Economics says, with 30-year fixed-rate mortgages at 2.71%, based on Freddie Mac figures.

Sure, pushing down long-term rates would further stoke the record bull-market by prodding investors to move more money from bonds to stocks. But that could increase Fed officials’ concerns about a market bubble that eventually pops, Bostjancic says.

So what is the Fed likely to do?

“it’s a close call,” Bostjancic says.

She, as well as economists at Goldman and JPMorgan Chase, expect the Fed to shift the bond purchases to trim rates while Nomura, Barclays and Morgan Stanley predict the Fed will stand pat.

How much would moves cut mortgage rates?

Some but not that much. Rates are already historically low and the housing market is booming. A shift in the Fed’s mix could push down mortgage rates by about 15 basis points, lowering the monthly payment on a $200,000 mortgage by $15, or $180 year, says Tendayi Kapfidze, chief economist of Lending Tree.

What else could the Fed do?

Many economists are more confident the Fed will provide more specific guidance on how low long it will continue to buy bonds. Currently, the Fed’s post-meeting statement simply says it will continue the purchases “over coming months.” Fed policymakers have said they want to provide a more detailed roadmap.

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Goldman Sachs believes the Fed will say it will keep buying bonds at the current pace until the labor market is “on track” to reach full employment and inflation is “on track” to reach 2%. That’s similar to the Fed’s criteria for raising its key short-term rate but not as rigid. It likely would mean the Fed starts tapering down the bond purchases in 2023, about a year before raising its short-term rate, Bostjancic says. 

Why a timetable for bond purchases?

Bostjancic says Fed officials likely want to avoid another “taper tantrum” – a 2013 spike in Treasury yields when Fed officials unexpectedly signaled they would start winding down bond purchases following the Great Recession of 2007-09.

Also, investors now expect the Fed to begin tapering the bond purchases in late 2021 or early 2022. By signaling a later start, it could spur more borrowing and cheer Wall Street, Bostjancic says.

Alexander, though, says the Fed may wait until the outlook is clearer before refining its guidance. 

How about Fed’s economic forecasts?

In September, the Fed predicted the economy would contract 3.7% this year and unemployment would end the year at 7.6%. But the economy has recovered from the pandemic more swiftly than expected, with unemployment already at 6.7%. Goldman Sachs expects the Fed to revise its forecast to a 2.5% contraction this year and unemployment of 6.8% at year-end.

Goldman also expects the Fed to modestly raise its estimate of economic growth next year to 4.2%, up from its prior forecast of 4%. Oxford, however, reckons the Fed will lower its estimate for next year as the effects of the virus spike outweigh the boost from the vaccine.