At its September meeting, the Federal Open Markets Committee announced it will begin reducing its $4.5 trillion portfolio of bonds purchased during the global financial crisis, as soon as October of this year.
This quantitative un-easing could have major consequences to the housing market as nearly 40% of the portfolio is made up of mortgage-backed securities that the Federal Reserve started buying in 2009, according to a blog from Mark Fleming, First American Financial Corp. chief economist.
The plan will begin in October this year with the reduction of $4 billion per month in mortgage-backed securities. The pace of MBS sales would then increase by $4 billion each quarter up to a maximum of $20 billion per month.
During the housing crisis, the Fed’s actions served to bring interest rates lower, lowered homeowners’ monthly payments and encouraged investment in the housing market, according to Fleming. Now, however, the quantitative un-easing could have the opposite effect.
Another expert agreed, but said the pace would be very slow as the Fed beings to sell its MBS.
“For much of the past decade, the Fed has been the largest investor in mortgages in the world,” said Mike Fratantoni, Mortgage Bankers Association chief economist and senior vice president for research and industry technology. “The Fed took the first step today to begin to shrink their holdings.”
“We expect that private investors will, over time, step in to buy MBS,” Frantantoni said. “But we can’t be certain how quickly they will replace the steady demand that the Fed has been providing.”
He added that the MBA doesn’t expect the balance sheet reduction to have a large impact immediately, as its beginning was very well telegraphed. As the pace of reductions increases through 2018, however, there could be a larger impact on rates, and the potential for additional rate volatility.
Fannie Mae estimates the un-easing could cause interest rates to eventually move up by 25 to 40 basis points.
And while Fleming explained this will not have a significant effect on existing homeowners, it could cause a drop in affordability for first-time homebuyers.
“Remember that the price of a home does not determine if it is affordable for a homebuyer. Rather, how much it costs each month to pay for the mortgage necessary to purchase the home given a down payment determines if it is affordable,” Fleming wrote.
“The amount a homebuyer can afford to borrow is determined by their income and the mortgage rate,” he continued. “The higher your income, the more you can afford. The lower the interest rate, the more you can afford.”
An analysis from Capital Economics explains that while Treasury yields could see some movement, the normalization of the balance sheet is not likely have a significant effect.
“According to the plans laid out at June’s FOMC meeting, the Fed’s balance sheet reduction is set to be extremely cautious,” Capital Economics wrote in its report. “The initial pace of the run-off will be capped at $10 billion per month, which is trivial relative to the size of the Treasury market, and the scale of the Fed’s monthly purchases when it was last accumulating assets.”
However, not everyone is convinced rates will not be affected, and say it is better to be prepared, just in case.
“The Fed's decision today to begin scaling back purchases of mortgage backed securities in October is likely to lead to an uptick in mortgage rates and may mean more volatility in rates,” Realtor.com Chief Economist Danielle Hale said.
“Home shoppers will want to adapt by considering their budget in light of current mortgage rates and thinking ahead about adjustments should mortgage rates move up suddenly. While a big sudden move in mortgage rates is unlikely given that the Fed decision was widely expected, it's always good to be prepared,” Hale said.
National Association of Realtors Chief Economist Lawrence Yun predicted mortgage interest rates would climb slowly upward, hitting 4% by the end of this year and 4.7% by the end of 2018.