By Ray Smith – Gateway Funding

As of March 31, 2010 the Federal Reserve ended a nearly 15-month-long, $1.25 trillion campaign of buying up mortgage-backed securities (MBS).  The program’s goal was to reduce borrowing costs for homebuyers.

The Fed’s efforts appear to have worked.  Rates were around 6.33 percent when the Fed announced that the program would start in November 2008.  Rates have fallen steadily ever since, hovering near historic lows for many months.  The Fed has officially stalled the program as of yesterday. What can we see as far as interest rates for the upcoming months?

You have probably seen everywhere that rates will rise because of the Fed’s decision to halt MBS purchases.  But why? MBS are tied to the bond market.  The bond market has many private investors who purchase and sell these securities on a daily basis.   In the days and weeks ahead, the private investors left to support new originator loan supply will be looking to find a yield spread level that puts the supply and demand of MBS into equilibrium.  Specifically, these traders will be trying to figure out (as we all are), based on demand from other traders, just how risky mortgage securities will be to buy and sell. MBS investment risk will be higher since the Fed’s exit (in fact the Fed will start SELLING mortgage backed securities!).  To compensate for a higher risk in the mortgage marketplace, investors will demand a greater return.  This greater return will congeal itself via moving rates higher on a gradual scale.  Investors also do not know the exact future of MBS supply so they will be going through a “feeling out” process.

BOTTOM LINE: The Fed’s exit could create higher rates because MBS investors want more for their risk of investing.  The “feeling out” period will make intraday trading volatile because supply and demand could change hands several times during a trading day.

To make things even more complicated, we must also account for economic news that has a firm grip on the movement of mortgage rates.  Things to look out for in the up and coming months are unemployment reports, supply and demand for new homes and jobs reports.  Remember, on a general scale, anytime you see good economic news it is generally bad for home mortgage rates because they are tied to the bond market.  Bonds and stocks have an inverse relationship.

BOTTOM LINE: With all evidence pointing to rates gradually rising, it is best to lock in and forget about it, especially if a settlement is going to occur in the next 30-45 days.  It is not worth the risk to possibly save $12-25 a month when you could lose out on a volatile market.