Dennis' Mortgage Blog

First we had Quantitative Easing in which the Fed bought Mortgage Backed Securities to lower interest rates, stimulate housing markets and slow foreclosures figuring housing market stability would lead to the economy growing.

That didn't work. 

Then we had QE2 in which the Fed bought more Mortgage Backed Securities and added U.S. Treasury bonds to the basket and put several hundred billion dollars into the economy to stimulate the economy and housing markets.   

That didn't work.

The new proposal appears to the "The Twist," which is what pundits and The Street are calling what will essentially be QE3.  The Twist would be a financial policy by the Federal Reserve to purchase sell much of its short term notes, those due in five years or less, and use the proceeds to purchase longer term notes, most notably 30 year bonds.

The idea is that the maneuver will lower longer term interest rates and stimulate the economy.  At the same time such a policy will not change the Fed's balance sheet and not put any additional money into the economy.  The theory is that lower long term interest rates will encourage borrowing and access to funds for investment in capital improvements and stimulate economic growth.

Will it work?  See above.

A couple of issues I see with The Twist.  First in regards to mortgage rates as an effect of The Twist we could see rates go up for mortgages instead of down.  Why?  For the past several weeks we have seen the 10-year Treasury note yield drop considerably, much more so than the 30 year mortgage rate.  For quite some time the spread between the 10-year yield and the 30 year mortgage rate has been about 1.3-1.5%, lately the spread have been more than two percent.  Had the spread from earlier this year held our rates today would be in the low 3% range.  Investors are not purchasing Mortgage Backed Securities with the same fervor they are Treasuries. 

Second, with the Obama Adminstration working on a policy to make it easier for home owners that are upside down to refinance (see my blog post here) the Fed is trying to lower long term rates.  Neither works well for investors who will see their current yields drop if successful.  This could lead to holders of Mortgage Backed Securities selling ahead of such a major refinance policy and/or the Fed beginning to Twist short term investments for long term.

Will The Twist work? Will it impact mortgage rates?  We won't know the answer to the first question for several months.  We should know the answer to the second question by tomorrow afternoon.

On the first Wednesday of November 2010, the day after the midterm elections, the Fed announced QE2 and we saw mortgage rates jump 0.25% in one week and one full percent in eight weeks.  What will happen after tomorrow's announcement?  I have been advising clients to lock in ahead of the announcement.