On Wednesday, Federal Reserve Chairman Ben S. Bernanke said the Fed will continue its policy of Quantitative Easing (QE) by purchasing additional mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. While the decision leads to no initial change in the Fed’s fiscal policy, Bernanke, in his statement following the FOMC meeting, laid out a possible road map for reducing and then ending the Fed’s bond buying program.
Bernanke said that if the economy and job market continue to improve, a gradual tapering down of the bond purchases could begin “later this year” with continued reductions next year until they stop in mid-2014, assuming the unemployment rate, now 7.6%, falls to about 7% by then.
However, Bernanke emphasized that such a strategy depends on the economy and job market. If they falter, the Fed could stop scaling back the bond purchases or even increase them again.
As expected, investors overlooked the continuing short term stimulus and hastily responded to the Fed tapering plan by sending stocks tumbling on Thursday. The Dow Jones industrial average tumbled 206.04 points, or 1.4%, to 15,112.19. The broader Standard & Poor’s 500 index dropped 22.88, or 1.4% to 1,628.93, and the Nasdaq composite index fell 38.98, or 1.1% to 3,443.20. The sharp rise in the yield of the 10-year Treasury bond, which rose to 2.33% from 2.18% Tuesday, might have also spooked investors as it hit its highest level in 15 months.
Numerous economists have come out in favor of the Fed plan as it shows signs of an improving economy. Conversely, many market participants are concerned about the impact of higher rates on the economy and the chance that Fed tapering could take them higher.
Freddie Mac’s Chief Economist has come out in support of the Fed’s policy and has said that, “low rates have helped fuel the recent good news in housing where home prices have been rising in most areas of the country. While it is true, the report says, that prices and rates work together to drive up the cost of buying homes, rates remain at near 60-year lows. At today’s home prices and income levels, mortgage rates would have to reach 7 percent before the median priced home would be unaffordable to families making the median income in most parts of the country.”
Evan as rates continue to rise, home affordability is still at an all time low in the United States. Today’s home buyers still have a significant advantage over those of past generations and will pay considerably less interest over the course of their mortgage than most.
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