The Federal Reserve has expressed plans to unwind its holdings of U.S. Treasuries and mortgage-backed securities (MBS). This “taper” will not happen overnight, and will likely begin after the Fed funds rate hike cycle is “well underway,” according to the Federal Open Market Committee (FOMC). But mortgage bond markets seem to be responding already. The question on many people’s minds is – will homeowners feel the pinch?
How Did We Get Here?
The Fed’s buying of MBS started in early 2009 when they pumped $5.6 billion – an overnight binge that marked the beginning of its plan to revive mortgage lending amid a historic home price rout. The U.S. housing sector gradually recovered, and the Fed stopped increasing holdings in 2014. But it continued reinvesting the proceeds from maturing securities to keep its MBS holdings from dropping off the $1.7 trillion level, which represents more than a quarter of the agency MBS market. The bottom line here is that the Fed’s consistent support was, and has been, a moderating force on interest rates, keeping housing affordability in check.
But now the punchbowl is being removed, so to speak. The Fed announced plans to pare down reinvestments in MBS – initially by $4 billion per month and eventually by $20 billion per month through incremental reductions over time. While that means the tapering is going to be ‘gradual’ and ‘predictable’ (as highlighted by the Fed), what cannot be ignored is that the U.S. mortgage market could be in for a major shift as an eight-year old pipeline of funds gets cut off.
Mortgage bond markets appear to be responding already – the yield spread on MBS has already climbed to 29 basis points over Treasuries, which is triple 2016 levels according to the latest values of Bloomberg Barclays U.S. MBS index. As yield spreads rise, it could mean that underlying loans – i.e., the mortgages of ordinary Americans – could see interest rates trickle up. If you have an adjustable rate mortgage, you may want to think about this potential shift even further.
Bottom Line for Investors
The key word in this story is “gradual.” The Fed does not appear to be in any hurry to unwind its balance sheet, and when it does, it will likely only do so in small increments. But, given the possibility of a large source of demand in MBS starting to taper off eventually, it follows that yields on mortgage products and interest rates on home loans are likely to feel upward pressure. At Zacks Investment Management, we can help strategize against changing market conditions while taking your financial goals into consideration. If you need help planning effectively for your financial future, call us at 1-800-701-7830. We’ll be happy to take your questions and also give you a free portfolio review.
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