Fed Begins Exiting Mortgage Market, Ending 'Punch Bowl' Days

(Update: Adds comment from Fed Chairman Jerome Powell in the last paragraph.)

The Federal Reserve voted unanimously on Wednesday to begin winding down its 19-month-old program for purchasing Treasuries and mortgage bonds that eased credit markets during the pandemic and sent home-loan rates tumbling to all-time lows.

“In light of the substantial further progress the economy has made toward the committee’s goals since last December, the committee decided to begin reducing the monthly pace of its net asset purchases,” the Fed said in a statement, referring to its policy-setting Federal Open Market Committee.

Having the Fed as the bond market’s biggest buyer since March 2020 forced investors to accept smaller yields, causing mortgage rates to hit record lows 15 times last year, as measured by Freddie Mac. In the first week of 2021, the average U.S. rate for a 30-year fixed mortgage reached an all-time low of 2.65%.

The Fed’s statement said it will begin cutting asset purchases by $15 billion per month: $10 billion in Treasuries and $5 billion in mortgage-backed securities. Since last year, the Fed had been buying $80 billion of Treasuries and $40 billion of MBS a month.

The almost $4 trillion of bond purchases since the beginning of the program pushed the Fed’s balance sheet to a record $8.56 trillion last month, about double the level it stood at when Covid-19 infections first started spreading in the U.S. last year.

The program, aimed at preventing the type of credit crunch seen after the collapse of the financial system in 2008, worked – perhaps too well, said Edward Pinto, director of the Housing Center at the American Enterprise Institute. Home prices surged at a record pace this year because the cheap financing meant homebuyers could qualify for bigger mortgages and bid higher for properties amid a shortage of available homes.

“The Fed has been spiking the punchbowl, and it’s long overdue that they stop driving home prices out of the reach of many first-time buyers,” Pinto said. “It’s better late than never, but this is long overdue.”

While the Fed’s withdrawal from the bond markets likely will cause mortgage rates to increase, no major housing forecaster is predicting a spike in home financing costs.

Fannie Mae economists project the average U.S. rate for a 30-year fixed mortgage will be 3.1% in the current quarter and 3.2% in the first three months of next year. By the end of 2022, the rate probably will average 3.4%, Fannie Mae said.

Higher interest rates likely will cause home-price growth to slow, said Odeta Kushi, deputy chief economist of First American.

“The Fed tapering likely will prompt mortgage rates to rise, but it does not mean that the housing market will crash, although we may see some cooling of purchase demand, and definitely a cooling of refinance demand,” Kushi said. “For purchase demand, context matters, and an improving economy and millennials aging into their prime home-buying years means the context remains good for the housing market.”

The tapering of bond purchases clears the way for an increase in the Fed's benchmark rate next year. Policymakers reiterated in their statement on Wednesday that it will be held near zero until the economy achieves maximum employment.

“We don’t think it’s time yet to raise interest rates,” Powell said at a press conference after the FOMC meeting, referring to the overnight lending rate the Fed charges banks. “There is still ground to cover to reach maximum employment.”