Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC): Are Rates Headed Higher?

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If you’re thinking about buying a home but are waiting for mortgage rates to settle back down, then I hope you’re in it for the long haul.

With the Federal Reserve scheduled to meet this month to decide on the fate of its monetary policy, many analysts and central bank observers are speculating that it may finally pull the trigger on beginning to wind down QE3. If it does so, you can rest assured the reverberations will be felt in the mortgage market — and no, the result won’t be lower rates.

Are rates headed higher?
To get an approximate idea of what could be in store for the mortgage market, the chart below shows what happened when the central bank merely intimated back in May that it could, at some undetermined point in the future, begin to reduce its support for the economy.

As you can see, the rates shot through the roof, climbing by more than 100 basis points over the course of two months.

Before getting to this, however, it’s first necessary to assess the likelihood that the Fed may indeed be on the verge of tapering. Although it’s never prudent to predict what the central bank will do, there’s a growing chorus of opinion that such a move is in order.

Earlier in the week, Mohamed El-Erian, the chief executive and co-chief investment officer of Pimco, suggested that it was all but certain that the Fed would do so. “The longer you stay unconventional, the greater the risk of policy ineffectiveness,” he told Bloomberg’s Tom Keene.

And on Friday, one of the most outspoken doves on the central bank hinted that he too could finally be in favor easing off the monetary gas pedal. As The Wall Street Journal reported, the official, Charles Evans, who is president of the Federal Reserve Bank of Chicago, acknowledged that he was “open-minded” about the idea.

So, what will happen to rates if it does so?
Similar to the futility of forecasting the Fed’s next move, it’s impossible to say how much rates will increase if it decides to taper its open-market bond purchases.

As Matthew Graham of MBS Live told me at the end of last month, “It’s easy to conclude that rates have baked in a portion of the eventual tapering announcement, but it’s hard to know how much.” At the same time, however, Graham was quick to note that, “we’ve priced a lot in, but probably not all.”

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