November 17, 2019

When Doves Cry


Beginning with the Bottom Line:


Equity markets rose again this week, including the Dow Jones Industrial Average cresting 28,000, on continued optimism around a U.S. and China trade deal. We examine the other tailwind provider – the Federal Reserve – as its Chairman Jerome Powell testified before Congress on monetary policy decisions and economic outlook. The Fed appears to have shifted from cutting rates to a pause until a meaningful turn in economic data. They gave no indication of long-term plans with their bond-buying program. They should focus on their mortgage bond redemption program if their secondary goal is to provide economic support. A pause in those redemptions could lower mortgage rates and provide a boost to housing and consumption. 


The Full Story:


On Wednesday and Thursday, Federal Reserve Chairman Jerome Powell testified on monetary policy and economic outlook before Congress’s Joint Economic Committee as well as the House Committee on the Budget. We’re only two weeks past the last Federal Open Market Committee meeting in which they decided to cut the federal funds rate by 0.25% for the 3rd time this year to 1.75%. After that rate cut, there were indications that they would pause further cuts and hold steady. You wouldn’t expect a shift in outlook or policy since that time, but both interest rate decisions and the length and strength of the Fed’s Treasury bill buying program were still up in the air.

The spoiler alert is that we’re still on pause until 2020, but here are the relevant parts.


Regarding interest rates:


“We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective.

We will be monitoring the effects of our policy actions, along with other information bearing on the outlook, as we assess the appropriate path of the target range for the federal funds rate. Of course, if developments emerge that cause a material reassessment of our outlook, we would respond accordingly. Policy is not on a preset course.”




Regarding the Fed’s balance sheet and bond-buying program:


“In response to the funding pressures in money markets that emerged in mid-September, we decided to maintain a level of reserves at or above the level that prevailed in early September. To achieve this level of reserves, we announced in mid-October that we would purchase Treasury bills at least into the second quarter of next year and would continue temporary open market operations at least through January. These actions are purely technical measures to support the effective implementation of monetary policy as we continue to learn about the appropriate level of reserves. They do not represent a change in the stance of monetary policy.




While the Fed has authorized $60 billion of new Treasury bill purchases each month, they are currently undergoing another balance sheet operation. The Fed has been allowing some of their mortgage-backed securities to roll off their balance sheet – approximately $20 billion per month – and reinvesting those proceeds in Treasury bonds.



The Fed started buying mortgage bonds issued by the U.S. agencies Freddie Mac, Fannie Mae, and Ginnie Mae at the bottom of the Financial Crisis to help shore up the housing market by increasing demand for those securities and the flow of credit. After successive rounds of Quantitative Easing, the Fed’s mortgage-backed security (MBS) portfolio reached $1.8 trillion.

Since October 2017, the Fed has been decreasing the size of its balance sheet in mortgages by allowing the private sector to absorb the mortgage securities. PIMCO estimates that the Fed’s shrinking mortgage portfolio has raised borrowing costs for homeowners who access credit through government-guaranteed mortgages by approximately 0.40% – 0.50%.

So, while mortgage rates are near historic lows (3.75% 30-year fixed-rate mortgage as of Thursday), they could be even lower if the Fed just reinvested its MBS portfolio rather than continuing to dump $240 billion of securities onto the market over the next year. This simple policy adjustment could have an impact similar to a cut in the federal funds rate, which the Fed clearly does not want to do and exhaust its ammunition before the next recession.



Although lower mortgage rates may hurt the financial sector, they have a couple of impacts on the economy. The first is the direct impact of investment in residential properties. Housing is an interest rate dependent sector as you would expect. Last year, as long-term interest rates were climbing (and the Fed was raising the federal funds rate), mortgage rates increased to near 5%, and investment in residential properties was a detractor to U.S. gross domestic product growth in each quarter. This year, as mortgage rates have fallen back below 4%, housing has fared much better and was actually a positive contributor to 3rd quarter 2019 GDP growth.



The second and indirect economic impact of lower mortgage rates is that lower mortgage rates allow for the quicker accumulation of equity as well as refinancing opportunities for greater disposable income or a higher savings rate. If we’re living in reality, it’s probably disposable income which further fuels the U.S. economy at 69.8% consumer spending.

Have a great Sunday!


Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist


Sources: Bloomberg, CNBC, Federal Reserve, PIMCO, JPMorgan
Author: Senior Investment Strategist Wealth StrategistSince joining W&A in 2014, Tim has been responsible for managing relationships with clients and providing financial planning services covering the areas of retirement, income tax, estate and gift, risk management, and education. In addition to client responsibilities, Tim serves on the firm’s investment committee assisting in portfolio construction and allocation as well as the searching and vetting of portfolio strategies. He is also an occasional author of W&A’s Weekly Strategic Insight commentary. Tim received his Bachelors in Accountancy and Masters in Taxation from the University of Mississippi in 2008 and 2009, respectively. He completed the CPA exam in 2011 and is a licensed CPA in the state of Tennessee. He earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) certification in 2014 and Personal Financial Specialist (PFS) credential in 2015. After completing his Masters at Ole Miss, Tim started his career at Reynolds, Bone & Griesbeck PLC as a tax associate in 2009. While at RBG, Tim worked with a wide range of clients, performing tax compliance and planning services for individuals, estates, trusts, partnerships, and corporations. Tim is a member and/or serves on the following organizations: • The American Institute of Certified Public Accountants • The Tennessee Society of Certified Public Accountants (Council member and VP of Programs and board of directors for the Memphis Chapter) • The Financial Planning Association (President-elect and board of directors for the Greater Memphis Chapter) Tim is originally from Marks, Mississippi, but has lived in East Memphis since starting his career. He is married, and he and his wife, Mary Agnes, are the proud parents to a son, Wilkes, daughter, Edie, and Goldendoodle, Penny.


Timothy W. Ellis, Jr., CPA/PFS, CFP®

Senior Investment Strategist

Wealth Strategist

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