As the Federal Open Market Committee's July meeting approached, investors paid close attention to what committee members were saying.
Even though most people anticipated the federal funds rate to remain unchanged—an accurate prediction—another order of business had investors' attention: the fate of the balance sheet.
The Fed's balance sheet is now $4.5 trillion, and Fed Chair Janet Yellen and her colleagues have made it clear that it's time to start bringing that figure lower. Savvy investors are eager to learn the details of this plan.
However, the statement that followed the most recent FOMC meeting did little to enlighten the general public, noting only that "the committee expects to begin implementing its balance sheet normalization program relatively soon."
The next scheduled committee meeting will take place Sept. 19-20, and a press release will follow. Many industry professionals expect more information to come from this meeting, Business Insider reported. As investors keep a close eye on the Fed to determine what the normalization plan might be, it's important that consumers understand how this could affect them.
The Fed's balance sheet is a list of all its assets and liabilities. Whenever the Fed purchases something, like a government security or a loan, it's recorded as an asset.
Following the financial crisis of 2007-2008, the Fed decided to expand its balance sheet by buying a plethora of bonds - bundles of mortgage-backed securities - and Treasuries. Many of the bonds were a burden to the banks, investors and others, because the mortgages were lent to people who couldn't afford them. The tactic of buying up those bonds is called "quantitative easing" or colloquially referred to as "printing money."
Buying these bonds from the various institutions and investors who held them was the Fed's way of helping these entities weather the housing market crisis and the financial fallout. Over the course of three major bond-buying sprees, the balance sheet grew. Today, bonds total $1.77 trillion, and Treasuries total $2.46 trillion, CNBC reported.
No one knows yet what the Fed's plan will be. However, there are two methods the Committee can choose from, CNBC explained.
The first option is passive. The Fed can let the bonds mature in their own time and choose to not reinvest the proceeds. The current policy is to reinvest and roll over the bonds when they mature.
The second option is active. This method would be to begin selling the bonds, whether they've matured or not.
Once the Fed chooses what its plan of attack will be, it will need to lay out a timeline. Will the Fed cease reinvesting or begin selling right away? Will it slowly stop reinvesting, or will no bond be reinvested after a particular date?
Acting too quickly or making too big of a change without warning could have a large impact on the market.
The Fed's decision regarding the balance sheet will largely affect investors and banks. However, that's not to say that the typical American shouldn't be interested in how the situation unfolds as well - particularly one considering taking out a residential mortgage.
Goldman Sachs Group Inc.'s strategists anticipate dropping bond prices as the Fed begins to shed its oversize collection, MarketWatch reported. As bond prices go down, Treasury yields go up.
Goldman expects the yield to increase 20 basis points before the year is over if the Fed moves as expected and begins to roll back its balance sheet this fall. Next, Goldman predicts yields to increase 12.5 basis points in both 2018 and 2019.
As yields increase, so do mortgage rates. A jump of 20 basis points in just the final third of the year is a lot and could cause interest rates to follow suit just as quickly. As a homebuyer, it's important to understand what current rates are and how they may change in the near or distant future. A smart move is to act when rates are low for increased savings over time.
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