We have all been hearing about Quantitative Easing (QE) and the Fed’s Balance Sheet for years now – without really understanding what it is or its effect on the market.
QE is where the Fed buys up both Treasuries and Mortgage-Backed Securities (MBS) in an effort to keep rates lower than they otherwise would be – because the Fed is providing so much additional “artificial” demand for those bonds.
There is much debate in regard to how much this actually helps rates, but it definitely does impact rates.
The effect of QE is probably the most impactful with respect to mortgages though because the Fed accounts for as much as 30% of the total market for Mortgage-Backed Securities (anywhere from $40 to $130 billion per month since COVID hit).
The Fed is continuing to purchase MBS en masse, but they are slowing down their purchases quickly – and threatening to not only STOP the purchases altogether – but to also start SELLING the massive MBS holdings on its balance sheet (almost $2 TRILLION).
So – this is what people mean when they talk about “The Fed’s Balance Sheet.”
When the Fed is buying MBS, its balance sheet is growing. When the Fed stops buying MBS, its balance sheet holds steady. When the Fed sells its MBS, its balance sheet will shrink.
So – just ceasing the buying of MBS will yank 30% of the total demand for MBS from the market – and that alone will increase mortgage rates by as much as 1%, per Barry Habib.
And the Fed is now slowing down its MBS purchases significantly, with promises to stop all buying this year – so that is scary.
But – what is really scary is the Fed’s comments about selling MBS in an effort to shrink its balance sheet.
(Politicians, investors and various Fed poohbahs all want the Fed’s balance sheet to shrink because the Fed’s mandate was never to own securities, particularly to this degree, and it creates too much uncertainty in the markets when the Fed holds trillions of assets)
If the Fed not only stops buying MBS but also starts selling them (decreasing demand and increasing supply), we will see an even stronger impact on mortgage rates.
And – that is The #1 Most Terrifying Factor That Could Push Rates WAY UP!
Will that happen?
Some prognosticators think we will see mortgage rates go as high as 6% before they level off or come down – and that will largely be a result of the Fed’s efforts to stabilize or shrink its balance sheet.
But – others think higher rates are going to impact asset (home and stock) prices too much causing much backlash from the public – and that the Fed then will panic and back off (and that much of the Fed’s talk right now is just bluster).
The latter also remind us often that the U.S. cannot afford higher rates because of our massive public and private sector debt loads.
There is another camp though that thinks inflation is now so out of hand that it will continue to push rates up no matter what the Fed does.
I personally remain in the “one more rate reduction camp” before rates start to trend up for a long time because the Fed and the Treasury will be forced to print vast amounts of money to cover the massive government deficits to come.
We won’t be able to emulate Japan (a country that has been printing money in droves for decades) because we have both government and trade deficits – where Japan only has government deficits (email me if you’d like to hear more about this).
The only certainty is that we will all learn more than we have ever learned before watching how things play out over the next few years, as we watch the Fed dance around inflated asset prices, record debt levels, record Fed balance sheet levels, record central bank interventions, geopolitical turmoil, demographic slowdowns, inflation and much else.
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167