Federal Reserve holdings of mortgage bonds have been a central component in how monetary policy affects the economy’s momentum. This key role was highlighted in a recent paper presented at a central bank research conference. The paper examined how the Fed’s actions of increasing or decreasing its holdings of Treasury and mortgage bonds, in conjunction with changes to its interest rate target, have influenced the overall economy.
Quantitative Easing (QE) refers to the Fed’s purchases of Treasury and mortgage bonds, which began in earnest in the spring of 2020. These purchases caused the central bank’s holdings to more than double to around $9 trillion by the summer of 2022. Specifically, Fed holdings of mortgage bonds increased from approximately $1.4 trillion to a peak of $2.7 trillion during this period. The significance of mortgage purchases is particularly noteworthy due to the importance of housing financing in the U.S. economy.
Economists and central bankers have long debated the effectiveness of these asset purchases in stimulating the economy. The recent paper presented at the Kansas City Fed’s annual Jackson Hole conference sought to provide concrete numbers on the impact of the Fed’s mortgage buying. The authors found that both banks and the Fed were each responsible for roughly a 40-basis point reduction in the mortgage spread during 2020 and 2021. This reduction led to a cumulative increase in mortgage originations of approximately $3 trillion, with net mortgage bond issuance totaling around $1 trillion.
The paper’s authors highlighted the significant impact that the Fed’s mortgage bond holdings had on consumer spending and residential investment. The reduction in mortgage rates resulting from the Fed’s actions led to increased mortgage originations and bond issuances, which in turn stimulated economic activity in these sectors.
As the Fed implements what is known as Quantitative Tightening (QT), the process of shrinking its balance sheet, the impact of its mortgage bond holdings becomes even more critical. QT involves allowing bonds to mature without replacing them, leading to a reduction in the Fed’s total holdings. Currently, the Fed’s mortgage holdings stand at $2.3 trillion, down from their peak of $2.7 trillion.
Despite efforts to reduce its bond holdings through QT, the Fed has faced challenges due to the sluggish state of the housing market and high borrowing costs. These factors have hindered the Fed’s ability to effectively reduce its mortgage bond holdings. Some analysts suggest that the Fed may need to resort to active sales of mortgage bonds in the future to achieve its goal of primarily holding Treasury bonds.
Federal Reserve holdings of mortgage bonds have a significant impact on monetary policy and the overall economy. The paper presented at the research conference sheds light on how these holdings influence consumer spending, residential investment, and the effectiveness of quantitative easing and tightening measures. Moving forward, it will be crucial for the Fed to carefully manage its balance sheet to navigate the complexities of the housing market and ensure the stability of the financial system.