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  • Jonathan Poyer

To what degree do Fed rate moves impact mortgage rates?

Updated: May 3, 2022

The economy is very complex and multi-dimensional such that moves in one part of the economy impact others.

That being said, Fed rates tend to affect short-term interest rates but not necessarily, or directly, long-term financing like mortgages.

Investors mostly decide the direction and scale of mortgage rates by buying, selling (or not buying or selling) mortgage-backed securities (MBS).

The Fed had been buying large amounts of MBS until late 2021 and ending those purchases in March. The process of decreasing overall MBS holdings is known as “normalization”. Recent Fed speakers have suggested a speeding up of normalization and even selling outright their MBS holdings. This outright selling would be a new and unprecedented change: (below through 4/27/2022):

Normalization is a larger issue for MBS than for US Treasuries, the other major source of the Fed’s attention in terms of asset purchases. Treasuries and MBS compete for the same investors, and they tend to move in the same direction. However, treasuries carry less risk than MBS, because the Federal government does not default on its obligations while mortgage borrowers sometimes do. MBS are also more susceptible to volatility.

So I wanted to look at how mortgage rates, 10-year treasuries, and the Fed’s MBS balance sheet have been moving in the long-term and also the short-term (through 4/27/2022):

Looking at the graph from 12/31/2019 to 4/27/2022:

The Fed’s selling off of their MBS positions is causing mortgage rates to increase at a faster pace than the 10-year yields. Thus, the MBS market is underperforming the treasury market despite all of the headlines touting the robustness of housing, supply/demand issues, fundamentals, etc. that we have spoken about in other places.

The mortgage market is not looking at rate hikes. Rather, it is looking at the Fed’s normalization outlook. How quickly will the Fed stop reinvesting MBS proceeds???

The bond market has priced in rate hikes and priced in some of that normalization curve:

The question is, has the bond market over- or under-accounted for the Fed’s normalization. With yields across the curve basically pushing 3, perhaps corporate and MBS bond investors can start to relieve some pressure on these fixed income markets. Or….are we only getting started with the bond market carnage?

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