Fed’s mortgage bond holdings play ‘central’ policy rule, says By Reuters newspaper

By Michael S. Derby

(Reuters) – The Federal Reserve’s mortgage bond holdings play a “central” role in how monetary policy affects the momentum of the economy, researchers wrote in a paper to be presented at a central bank research conference on Saturday.

The paper takes stock of how the Fed uses increases and contractions in its holdings of Treasuries and mortgages to boost changes it makes to its interest rate target, actions collectively meant to influence the economy’s momentum.

Known as quantitative easing, or QE, the Fed’s purchases of mortgage bonds and Treasuries, which effectively began in the spring of 2020, doubled the central bank’s holdings to a peak of about $9 trillion by the summer of 2022. The Fed’s holdings of mortgage bonds rose from about $1.4 trillion in March 2022 to a peak of $2.7 trillion.

Mortgage purchases are particularly notable given the importance of housing finance factors in the US economy. But economists and central bankers have long struggled to measure the impact of asset purchases, and some have doubted their value.

The paper, which was written by a group of economists for a presentation at the Fed’s annual research conference in Kansas City, Jackson Hole, Wyoming, presented some numbers on the impact of the Fed’s mortgage purchases and explained how the process works, mentioning private banks. also plays a role.

“We find that banks and the Fed were each responsible for about a 40 basis point reduction in the mortgage spread over 2020/21,” the paper’s authors wrote. “This led to a cumulative increase in mortgage originations of about $3 trillion and net (mortgage bond) issuance of about $1 trillion, with banks responsible for about half of that increase.”

“These effects had a large impact on consumer spending and residential investment,” the paper said.

The strong role the Fed’s mortgage bond holdings have on the potency of monetary policy is also at work as the Fed pursues what’s called quantitative tightening, or QT. This process has caused the Fed to shrink its holdings to $7.3 trillion — the Fed’s mortgage holdings now total $2.3 trillion — because it allows bonds to mature and not be replaced. QT has moved in tandem with a process of Fed rate hikes and will likely continue to operate even when the Fed cuts rates, although it is unclear when QT will end.

The Fed’s QT process has proven slower than some expected, as the moribund state of the housing market amid high borrowing costs has slowed mortgage origination, in turn dampening the Fed’s ability to take mortgage bonds off the books. At some point, some believe the Fed may even have to resort to active sales of mortgage bonds to fulfill its desire to hold mostly Treasuries.