Even with last Tuesday's half-point cut, analysts are not expecting long-term rates to edge that much lower going forward.
Analysts said that with the economy expected to rebound by the second half of next year, the Fed is expected to switch to a bias towards tightening.
In a stronger economic environment, the Federal Funds rate would not be kept at 2% or below. This is because the Federal Reserve would start hiking the Federal funds rate at the first sign of an economic recovery. So instead of an era of falling interest rates, the country is going to experience an era of rising interest rates.
"I think the current quarter will be the bottom of the recession," said OrawinVelz, an economist at Fannie Mae."With the stimulus package and the Fed easing that has been done since January, economic growth should pick up strongly by the third quarter of next year."
Mortgage rates are also not expected to edge much lower, either. Fannie Mae economists predict that quarterly rates are going to bottom in the first quarter, averaging around 6.3% to 6.4%.
"As a home buyer you might want to sit on the fence and wait for rates to bottom out but you can completely miss it too, " said Velz.
Effect on MBS
After the Fed rate cut on Tuesday, mortgages did pretty well as spreads tightened. But with Wednesday's rally, spreads widened because of prepayment concerns.
Analysts said that at these rates it is pretty difficult for mortgages in the 6% coupon and higher to appreciate by much more.
"We are currently very market directional," said an MBS analyst. "If 10-year rates come down 25 basis points, we are going to see mortgages widen by five to eight basis points. If rates go up 25 basis points mortgages are probably going to tighten five to seven basis points."
The market direction at the long end - what the 5 to 10 year Treasurys do - is the dominant factor that would determine how mortgages perform vis a vis other spread product.
According to David Montano, head of mortgage research at Credit Suisse First Boston, the difference between now and 1998 is the steepness of the curve, and therefore mortgage duration is not as short as it was in 1998.
"It is expected to keep banks as the major investors in the market but because banks were heavily buying earlier in the year and the markets have rallied substantially, banks also need to figure out what they have to do with their paydowns on 6.5s and 7s," Montano said.
Banks are expected to buy lower coupon mortgages, probably 15-year product and CMOs.
