The Fed won't sell MBS any time soon. Now what?

Mortgage rates have surged in response to inflation and related monetary policy actions, but recent comments from Federal Reserve Chairman Jerome Powell allayed at least one worry for those in housing finance — for the time being.

By announcing that the Fed won't be selling off mortgage-backed securities from its portfolio any time soon, Powell provided some near-term relief for lenders worried about added rate volatility in their market.

"The positive in yesterday's announcement is that the Fed did not announce any ramped up expectations of sales," David Battany, executive vice president of capital markets at Guild Mortgage said.

The Fed could use sales of mortgage-backed securities from its $2.7 trillion portfolio as a tool in the fight against inflation. That's been a worry for housing finance firms because they see MBS as more closely tied to home loan rates than other levers the federal officials might pull for this purpose. Already the Fed has stopped growing its portfolio and allowed $35 billion in MBS to go into runoff each month, only buying if that amount is exceeded.

If the Fed sells MBS, effectively reversing the pandemic stimulus that contributed to record-low mortgage rates over the past two years, financing costs could surge further.

But now — even though Powell has said he still thinks it's something policymakers will eventually turn to — some lenders think it's increasingly likely it won't happen, particularly if the recession some economists are forecasting occurs.

"I believe they will not consider selling MBS at all," said Shmuel Shayowitz, president and chief lending officer at Approved Funding. "Certainly, if inflation spikes after their final two rate hikes, that would be [an arrow in their] quiver they use to calm the markets, but I don't see them pulling that lever. I believe that inflation numbers might start stabilizing."

Shayowitz thinks monetary policymakers will exercise some caution around actions that could unduly weaken the housing market but some other experts note that Powell could be somewhat aggressive on that front given that the Fed chairman said he wants to bring "shelter inflation" down.

"They want to see a housing price correction, so they're probably holding onto the tool of outright selling the [securitized] mortgages as a backstop if they can't get where they need to with interest rate hikes," said Sadie Gurley, who currently works for a New York fund investing in residential mortgages, and previously was a senior vice president at Maxwell Capital.

The Fed could also decide to start selling MBS if runoff proved to be insufficient to achieve the targeted reduction of $35 billion per month, Gurley said. With reduced opportunities for refinancings as rates rise, that's increasingly possible.

"If prepayments slow down to the point where [MBS are] not rolling off fast enough, that's when they're going to go to that second level, which is to sell the bonds," she said.

But even if the Fed does hit the point where it sells mortgage bonds, it'll be limited by the fact that many of the MBS that will be sold are older and have less bearing on current rates than newer ones would.

"The bonds selling would be [largely] seasoned loans, non TBA, and [lower] coupons. The investors who want those may not always be the same investors that are buying current [to be announced MBS]…which support the daily rate sheet from mortgage lenders," Battany said. "So I think the net punchline is yes, that could push mortgage rates up, but not to the full extent MBS buying pushed them down."

The performance of these coupons did initially improve after Powell's comments made it clear additional supply wouldn't be immediately delivered into the market by the Fed, as some had been anticipating, but a broader selloff in bonds Thursday over inflation uncertainties reversed that.

"The market has been expecting the Fed to begin selling securities in the not-too-distant future, so we saw outperformance of lower coupons early on, but there's been a lot of selling pressure today," said Justin Hoogendoorn, head of fixed income securities and analytics at HilltopSecurities. "It's orderly but all coupons are selling off."

Hoogendoorn cautioned that while the composition of the Fed's MBS portfolio does partly mitigate the upward pressure on mortgage rates that could result from sales, it wouldn't eliminate it.

"If a lot of 2s and 2.5s hit the market it would still have an impact but it would be limited," he said.

Also, Treasuries that could eventually be sold from the Fed's portfolio could exert upward pressure on rates.

"If the Fed is selling some MBS, it's very possible at the same time, they can also be selling their Treasury bonds, and if the Fed starts selling 10-year Treasury bonds, it's just one market. It doesn't matter if a bond is seasoned or not seasoned. So definitely as they sell 10-year Treasuries, that will push up the [rate-indicative] yields," Battany said.