Taxes, Taper, and a Technical Breakout

Home loan rates were mainly unchanged this past week. Let’s break down what is threatening the financial markets and rates.

The Taper Threat

A big threat to stocks, bonds, and rates is when the Fed will announce a tapering or scaling back of bond purchases. Presently the Fed has been buying at least $120B worth of Treasuries and mortgage-backed securities (MBSs) every month. This Fed buying is the main reason why home loan rates remain near all-time lows.

With inflation elevated and froth in the housing market, there is growing pressure on the Fed to start buying fewer bonds – and there is speculation the Fed will start tapering by purchasing fewer MBSs.

No one knows what, if and when the Fed will do anything, but if the Fed buys fewer MBSs, home loan rates will likely move higher. Back in 2013, when the Fed mentioned the word “taper” home loan rates shot up 2.5% over the next 6 months. The Fed knows this and is trying to scale back purchases without causing a similar disruption.

The next Fed Meeting Monetary Policy Statement will be released on Wednesday, Sept 22nd at 2:00 p.m. ET. We will find out soon enough if the Fed is confident enough to scale back bond purchases and not trigger a taper tantrum reaction in the bond market as we saw back in 2013.

The Tax Threat

The Administration and Congress are trying to pass a $3.5T spending plan that will include various tax hikes. There is a concern in the financial markets that a broad range of tax hikes could lead to slower economic growth, at a time when economic growth is already decelerating. Stocks don’t like the idea of slower growth and have been under selling pressure of late as details of the $3.5T plan have emerged.

Normally bonds and rates would do well when stocks suffer. But that has not happened this past week. Bonds are worried about the taper threat and the idea that a large $3.5T plan could put upward pressure on rates as the bond market has to absorb all the new bond issuance required to fund the enormous spending plan.

Much like the taper threat, no one knows how big the spending plan will ultimately be and what taxes will be included. Once something is close to being passed, stocks, bonds, and rates will react accordingly.

Bottom line: We do not know if the Fed will also announce a “modest” tapering in bond purchases next week or how the bond market will react. At some point, the Fed will have to scale back purchases and when it does, we should expect an increase in rates.