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How High Will Interest Rates Go in 2016?

Federal Open Market Committee Has the Answer

Frank Nothaft    |    Mortgage Performance

Now that the Federal Open Market Committee (FOMC) has dipped its toe in the rate increase water, are they more likely to wade in slowly or jump in? Each quarter, the FOMC provides its economic projection and details on each of the 17 members’ view on the level of the federal funds rate[1], with the last projection having been released after the December 16 FOMC meeting[2].  In the accompanying chart, each circle shows an individual participant's view of the appropriate target range for the federal funds rate at the end of each calendar year or over the longer run. The line in the chart plots the median of all members’ views on the federal funds rate target for the same time periods. The consensus view among FOMC participants is that rates are certainly going higher. For 2016, the smallest increase in the target rate given expectations in the performance of the economy is 50 basis points. The median increase for 2016 is 100 basis points, but this assessment could change if expected economic performance either strengthens or weakens. One thing is clear: the era of near-zero short-term interest rates is history.

Further out, the median of the FOMC members’ assessment shows there is another 100 basis point increase in the target rate for the 2017 calendar year, and an increase of just under 100 basis points for 2018, with a gradual return to the longer-run equilibrium steady state rate of 3.5 percent. The longer-run level would be the highest federal funds rate since January 2008.

So what does all of this mean for mortgage rates? Mortgage rates will increase, but not by as much as the federal funds rate, which will lead to a flattening of the yield curve. Long-term, fixed mortgage rates should rise less in the near term partly because the Federal Reserve will be buying mortgage-backed securities to offset pay downs in its MBS portfolio. This demand will bolster MBS prices, mitigating upward pressure on mortgage rates.  Interest rates on adjustable-rate mortgages will likely see an effect sooner because they are indexed to short-term interest rates. In particular, interest rates on home equity lines of credit (HELOCs) are often tied to a bank prime, which typically moves in lockstep with the federal funds rate.



1 The members’ views were as expressed at the December 16, 2015 meeting, which predated the significant volatility in global markets that came at the end of 2015 and early 2016.

2 Materials from FOMC meetings are found here: http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. The details on the FOMC participants’ assessments of appropriate monetary policy for the December 16, 2015 meeting  can be found here: http://www.federalreserve.gov/monetarypolicy/fomcprojtabl20151216.htm.

Note:  Molly Boesel co-authored this blog.

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