End of Fed bond buying may nudge mortgage rates

The Federal Reserve this week is expected to remove one of the two crutches supporting the economy since the 2008 financial crisis, ending bond purchases that have held down long-term interest rates.

The anticipated decision to halt so-called quantitative easing at a two-day Fed meeting that begins Tuesday marks a milestone in the recovery. But it's drawing little fanfare and economists expect minimal effect on financial markets, though it could push up mortgage rates slightly.

That's because Fed policymakers have been signaling the decision for months and winding down the bond-buying, begun in late 2012. And the strengthening economy is largely being driven by other forces.

"This has all been fully telegraphed," says Paul Ashworth of Capital Economics, noting the move is priced into bonds.

Also, the Fed's other economic crutch — historically low short-term interest rates — remains in place, likely until mid-2015.

Many economists say the Fed's purchases of Treasuries and mortgage-backed securities sparked a bit more mortgage and other lending and boosted stocks. Its impact recently has been muted, largely because the Fed has tapered the monthly purchases to $15 billion from $85 billion in December as job growth surged.

The Fed's exit will remove a big buyer. But Ashworth notes the Fed still holds about $4 trillion in securities it has snapped up since 2008. That will keep market supplies and rates low.

Other factors are keeping a lid on U.S. borrowing costs, says analyst Anthony Valeri, of LPL financial. The strong dollar, low U.S. inflation and the eurozone's weak economy — where interest rates are even lower than in the U.S. — are driving foreign and other investments to Treasuries, pushing down their yields.

The Fed's withdrawal from the Treasury market could have a bigger effect if the economy heats up, says economist John Lonski of Moody's Investor Services. "It will heighten anxiety about the first rate hike," pushing up yields more quickly.

Mortgages could be more affected, with rates rising about 10 basis points, Lonski says. The Fed owns 38% of outstanding mortgage securities, vs. 22% of outstanding Treasuries.