Jun 22, 2009
Having invested $1 trillion into the economy, Chairman Ben Bernanke now faces the daunting task of convincing investors that the Federal Reserve can make up this amount. Bernanke and his colleagues are set to agree, on June 23-24, that the government needs to continue its strategy of buying assets in order to maintain low interest rates. Though this is geared to revive growth, the rising Treasury bond yield are indications that investors are concerned that sustaining such a strategy will lead to a long-term inflationary pressure.
According to Lyle Gramley, an economic adviser from Soleil Securities, “markets don’t understand the Fed’s exit strategy” and this is a cause for concern. This confusion contributed to the higher rates in long-term investments. The risk in having higher rates lies in the fact that it will hinder economic growth by lifting the cost of borrowing for home buyers.
Mounting Mortgage Rates
Earlier this month, the average mortgage rate for a 30-year loan actually rose to 5.59 percent which is the highest since November of last year. Because of this, the number of mortgage applications dropped to 16 percent in the week ending June 12. The Mortgage Bankers Association also revealed that the increase in rates had discouraged refinancing.
How the Fed Plans to Contain the Cost
Fed officials are looking at many options to contain borrowing costs in the market. Right now, it seems that they want to use policy statement to stop speculations that they’re prepared to boost the interest rates this year. According to a the chief economists at the Bank of Tokyo-Mitsubishi UFJ Ltd. located in New York, everyone is thinking of the exit strategy because they are “worried about the future”.
If policy makers intend to restrain rates, they need to explain how they can prevent inflation from growing at an uncontrollable pace. It is not only the US that has to deal with this problem though because there are also talks in the European Central Bank on how they can reverse their stimulus.
Unless the Fed provides clarity on its exit strategy, investors, analysts, and even the public will conclude that the back-up in interest rates will create problems in refinancing and housing in the future. And there is a high chance that it will.
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