Fed to raise short-term rates, shrink balance sheet

Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a live-streamed news conference following a Federal Open Market Committee (FOMC) meeting in New York, U.S., on Wednesday, March 16, 2022. The Federal Reserve raised interest rates by a quarter percentage point and signaled hikes at all six remaining meetings this year, launching a campaign to tackle the fastest inflation in four decades even as risks to economic growth mount. Photographer: Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

Monetary policy officials Wednesday afternoon confirmed plans to begin raising short-term rates for the first time since 2018, and said they would allow the Federal Reserve’s portfolio of mortgage and Treasury bonds to roll off as soon as May.

The moves could challenge lenders by boosting long-term rates for home loans, further reducing origination volumes, but they could also have an upside for lenders if the measures stabilize the shaky bond market.

“Rates have been exceptionally volatile in recent weeks, given the profound uncertainties both with respect to the geopolitical situation and monetary policy,” said Mike Fratantoni, chief economist and senior vice president at the Mortgage Bankers Association, in an emailed statement. “Hopefully the Fed’s actions and explanations can help to reduce the policy uncertainty.”

Securitized home-loan spreads were tightening immediately after Federal Reserve Chairman Jerome Powell’s press conference, indicating his comments had stabilized the market somewhat, according to an intraday report by Walt Schmidt, senior vice president and manager in FHN Financial’s mortgage strategies group. Powell said the process of unwinding the balance sheet would be “familiar” and “somewhat faster than last time.”

While pricing for 30-year mortgages isn’t directly correlated with the Fed’s short-term rate moves, there is a relationship between the two. The balance sheet shrinkage, which affects the mortgage-backed securities market, plays a more direct role in influencing home loan rates.

“While changes to the Federal Funds rate may not directly impact mortgage rates, ‘quantitative un-easing’ does place upward pressure on mortgage rates,” said First American Deputy Chief Economist Odeta Kushi in an emailed comment.

Even if the Fed’s actions help stabilize the bond market, mortgage rates could continue to be unpredictable given the heightened global tensions and the fact that they often make counterintuitive moves in short-term reactions to monetary policy developments. Lenders may choose to hold rates low for consumers as long as their business models can bear it to compete in a contracting market, even with the Fed raising short-term rates and shrinking its balance sheet.