U.S. Mortgage Rates Slip, Fed Course Affirmed?

Freddie Mac reports that mortgage rates fell in the U.S. in the past week. The average 30-year fixed rate mortgage fell 10 basis points to 5.32%. Fed officials may find some comfort in this development, but it is unlikely to silence its critics.

In some ways the Fed is damned if they and damned if they don't. Some pundits have been critical of the Fed for buying any long-term assets. Others believe the Fed needs to buy more. The Fed has done two things recently that this second group of critics find particularly frustrating. They have taken steps that slow their purchases of Treasuries and did not expand its long-term asset purchases at the June FOMC meeting in response to the sharp backing up of interest rates.

It has a little more than $100 billion to go of its $300 billion commitment. At the new pace, the Fed does not have to make a decision about its future intentions at the August FOMC meeting. It can, at least theoretically, wait until the September 23 FOMC meeting.

The fact that the Fed did not respond to the backing up of interest rates demonstrates, at least in part, what they have been saying. They are not targeting a particular rate. Fed officials have recognized some role in the backing up of interest rates as a function of the large supply, but tend to emphasize the easing of the economic and financial crisis.

Some Fed officials have opined that the asset purchases have been successful insofar as it did help fuel a mini-refinancing boom that arguably helped reduce some stress. Even if the Fed is not targeting a particular interest rate, it obviously wants to avoid a situation in which the backing up of interest rates will choke off the recovery and the healing of the housing market.

This poses a dilemma for the dollar. For people trying to understand the dollar through the debt market, there is no winning for the dollar. If investors are buying bonds and driving yields lower, we are told the dollar is not attractive. If investors are selling bonds, we are told, this is obviously not good for the dollar either.

Many investment houses appear to be recommending selling of Treasuries for German bunds on ideas that the U.S. is likely to recover before the Continent. We have argued that the relationship between the dollar and interest rates is not linear but cyclical. We too expect interest rate differentials to continue to move in the U.S. favor and expect that this will give the dollar better traction. It will, of course, require that the current relationship by which the dollar rallies on bad news has to break down more convincingly.