The Federal Reserve’s decision to end its era of easy money is rippling through the mortgage market, driving up the cost of buying a home.
The central bank had been the biggest buyer of pools of home loans since the start of the pandemic. Now it is reversing course, winding down its purchases and laying the groundwork to shrink the $2.7 trillion stockpile it has built up. These mortgage-backed securities, hot investments for much of the pandemic, are now selling off.
“When you go from quantitative easing to quantitative tightening in two months, this is what happens,” said Walt Schmidt, a mortgage strategist at FHN Financial.
Recent market ructions have hammered securities of all stripes, from blue-chip stocks to junk bonds, pressuring many of the bedrock holdings in investors’ stock-and-bond portfolios. Prices of Treasurys also have fallen and yields have risen, meaning the cost of borrowing stands to climb across the board.
The upheaval in mortgage bonds affects households in an especially direct manner. Less demand for mortgage bonds means issuers must offer higher yields to attract investors. So lenders have to raise interest rates on the mortgages inside those bonds. Already, the 30-year fixed mortgage rate is around its highest level since the beginning of the pandemic.
“As the purchases wind down, it will disproportionately hit demand for MBS,” said David Battany, executive vice president for capital markets at Guild Mortgage Co.
Last Wednesday, when the Fed sent shudders through mortgage bonds by laying out its plans, mortgage lenders adjusted their rates rapidly. Mr. Battany estimates that a typical mortgage interest rate climbed about 0.06 percentage point from the period just before the Fed announcement to the days after the Fed announcement.
The recent market moves are in many ways the mirror image of what happened in the spring of 2020. As the nation shut down to stop the spread of the coronavirus, the Fed jumped into action, saying it would purchase trillions of dollars worth of securities. Prices on mortgage bonds climbed and yields fell. Record low mortgage rates prompted a boom in refinancing.
At the same time, businesses and individuals held on to cash in their bank accounts and decided to borrow less. That gave banks trillions of dollars worth of deposits that needed a home. Some banks stowed that money in mortgage bonds. Bank of America Corp. , for example, had more than half a trillion dollars of mortgage bonds on its books at the end of last year. But with the Fed expected to lift rates soon, banks may take some of that money out of storage.
Between the Fed and the banks, mortgage bonds stand to lose some of their biggest buyers. Money managers own a small fraction of the total market, and analysts say it is unclear how much more they are willing to buy at current market levels, creating a potential gap between supply and demand.
The extra yield that investors demand to own mortgage-backed securities instead of Treasurys has risen by roughly a quarter of a percentage point this year, according to Tradeweb. That gauge, which compares a mortgage-backed securities index to 10-year Treasury yields, was last week at its highest since the early days of the pandemic.
Some analysts say these spreads will likely widen further.
“I think we are somewhere between 50% to 60% of the way through” the current market move, said Satish Mansukhani, a mortgage-backed securities strategist in Bank of America’s research group.
Mr. Schmidt, of FHN Financial, said that based on historical moves in the market immediately after the financial crisis, he expects spreads to rise by another 0.1 to 0.2 percentage point.
Write to Ben Eisen at [email protected]
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