House prices could fall if the Fed winds down its bond-buying program. But a crisis? Unlikely.

US house prices have risen at a record annual rate in recent months, partly due to historically cheap credit, the absence of real estate for sale and households clamoring for more space as families have fled to the suburbs during the pandemic.

Can the good times continue when the Federal Reserve finally cuts back on buying mortgages and government bonds? Here’s how mortgage rates and a less gigantic central bank footprint could impact the heated US housing market.

“The Fed is certainly talking and thinking about it,” said Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research, of how the Federal Reserve is pushing the central bank’s $120 billion-a-month bond-buying program. could roll back. .

But Jones also thinks tighter credit conditions, likely via higher lending rates as the Fed winds down its bond-buying program, could ultimately help save the current housing market.

“House prices could definitely fall, after rising so quickly,” she said, pointing to households fighting over the few properties available to buy, while navigating from home. “At some point,” she said, mortgage payments on expensive homes become “unsustainable with people’s incomes.”

“But I don’t see a major housing debacle.”

How to pump the brakes on the case?

The central bank has had a large footprint in the mortgage market for more than a decade, but the worsening affordability crisis in the US housing market recently led Fed officials to a tightrope as they tried to explain its ongoing large-scale asset purchases during the pandemic recovery. .

Fed officials have expressed quite a bit of disagreement in recent weeks about the timing and pace of scaling back large-scale asset purchases.

St. Louis Fed President James Bullard said on Friday that the central bank should slow its bond purchases this fall and end in March, saying he thought the financial markets are “very well prepared” for the cut in buying. .

Speaking at a midweek press conference, Chairman Jerome Powell said the phase-out would likely begin with mortgage-backed securities (MBS) and government bonds at the same time, but “the idea of ​​reducing “mortgage exposure” at a slightly faster pace is also having some traction with some people. “.

The blue line in the graph below shows the balance and abrupt path to a balance sheet of $8.2 trillion since 2020, when his efforts to support the markets during the pandemic began, with the red line representing his Treasury TMUBMUSD10Y,
holdings and green line are MBS. MB,

Fed holds major cards in MBS and Treasury markets

St. Louis Fed Data

On July 29, the Fed held the about 31% of the approximately $7.8 trillion MBS market, or government-backed housing bonds.

“You could argue that the Fed owns nearly a third of the agency mortgage bond market, and it might make sense to loosen its hold,” Jones said, especially since Powell has a direct link between its MBS purchases and rising prices. house prices.

It may seem like a distant memory now, but before the pandemic turn, that was exactly what the Fed was trying to do.

“Who would have thought,” said Paul Jablansky, head of fixed income at Guardian Life Insurance, that the US would find itself in the midst of “one of the frothiest housing markets in history” following last year’s extreme pandemic shutdowns that saw businesses shutting down. , workplaces and national borders.

“Sometimes people ask, are we at the peak?” said Jablansky, a 30-year veteran of the mortgage and asset-backed and broader bond market. “We’re off the balance of our experience, so it’s very hard to say we’re at the peak,” he told MarketWatch.

“I do think that house price inflation will have to slow down drastically. But perhaps the biggest question is: can we see house prices turn negative? I think the Fed will work very, very hard to create a soft landing for housing prices.”

Schwab’s prediction was that the Fed would kick off by cutting its monthly asset purchases by $15 billion to $105 billion. That would mean cutting $10 billion from the current $80 billion monthly rate of Treasury purchases and $5 billion from the $40 billion monthly rate of MBS.

“Until now, we haven’t changed that,” Jones told MarketWatch.

Although the Fed does not set long-term interest rates, the Fed is trying to keep borrowing costs under control by buying up government bonds en masse. The interest on government bonds also determines the interest component of mortgages with a maturity of 30 years. So maybe it makes sense to scale back both at the same time, Jones said.

Misremembering the 2013 taper

Fed Chairman Powell said on Wednesday that the central bank’s “substantial further progress” target for unemployment and inflation in particular has not yet been met, while stressing that it would like to see more progress in the job market before easing monetary policy support to the economy.

Powell has also often talked about lessons learned from the 2013 market upheaval, the “taper tantrum” that shook markets after the central bank began talking about taking the punch bowl out as the economy recovered from the Great Recession of the United States. 2008.

“What we need to remember,” Jablansky said, is that markets are sold out in anticipation of winding down, not the actual withdrawal of asset purchases. “Later in the year, the period [former Fed Chair Ben] Bernanke talked about the Fed actually continuing to buy assets and the amount of accommodation it provided to the economy actually went up.

Historically, the only period in which the Fed has actively withdrawn its support has been between 2017 and 2019, following its controversial first attempt at large-scale asset purchases to release credit markets after 2008.

“It’s very difficult to draw many conclusions from that real short period of time,” Jablansky said. “For us, the conclusion is that 2013 may be instructive, but the circumstances are really different.”

To see: Why the Fed’s Balance Sheet Is Expected to Cross $9 Trillion After It Begins to Cut Its Monthly Asset Purchases

Powell’s message has always been about maintaining “maximum flexibility, but very slowly,” said George Catrambone, head of Americas trading at asset manager DWS Group.

Catrambone thinks this may be the right strategy, given the uncertain outlook for inflation, as evidenced by the recent spike in the cost of living, but also because many of our lives have changed as a result of the pandemic.

“We know that a used car will not cost forever more than a new car,” Catrambone said. “Do I think the housing market is slowing down? It could be. But you really need the imbalance between supply and demand to reduce. That could take a while.”

Extreme wildfires, droughts and other climate change shocks are linked to $30 billion in property losses in the first half of 2021, while more tracts of land and American homes are at risk. While these were less frequent topics in the housing market in 2013, the pandemic also changed the whole idea of ​​”what’s safe” for many families.

“Migration patterns are often sticky,” Catrambone said of the flight from urban centers to suburbs.

In addition, the delta variant fueling a new wave of COVID-19 cases has led to stricter masking and vaccination policies, including at Alphabet Inc., GOOG,
Facebook Inc. fb,
and others, as well as delayed plans by many major companies to return staff to office buildings.

“This is likely not going to benefit commercial property occupancy rates as more people are likely to stay closer to home,” Catrambone said, but it likely adds to the already high “psychological value placed on housing.” ”

After touching record highs, the S&P 500 index SPX,
Dow Jones Industrial Average DJIA,
and Nasdaq Composite Index COMP,
closed Friday and the week lower but posted monthly gains.

As for US economic data, August starts with manufacturing and construction spending data, followed by motor vehicle sales, ADP employment and unemployment claims, but the main focus of the week will be Friday’s monthly nonfarm payroll report.

Read: Climate risk strikes for state and local governments