The impact of Federal Reserve’s policies on the residential mortgage markets

Abstract

Post Global Financial Crisis (GFC), the Federal Reserve adopted a new tool for temporary quantitative easing (QE) by purchasing agency mortgage-backed securities and Treasury securities from the market in an attempt to resurrect the economy. This unconventional method of restoring the capital markets proved innovative and effective. During the COVID pandemic, the Federal Reserve continued to purchase more securities to stabilize the markets resulting in a vast expansion in its balance sheet.

In the current inflationary environment (2022), the Federal Reserve is running losses on the balance sheet as it increases the interest rates as part of its quantitative tightening policies; the Federal Reserve must consider whether to sell its current MBS holdings according to its plan or hold on to the portfolio. The residential mortgage market faces additional liquidity pressures and uncertainty with limited Federal Reserve support.

Inspecting the spread between the 10-year Treasury yield and fixed 30-year mortgage rates during times of crisis and stable markets, this thesis investigates current market uncertainty and the impact of shocks that increase the spread, which translates into higher mortgage rates and lower affordability for the borrower. This thesis concludes the asymmetry of Federal Reserve policies may never work but adds uncertainty to the residential mortgage markets.