Two Fed. Moves Will Push Mortgage Rates Higher

Interest rate hikes indirectly affect long-term mortgage rates – but a separate Federal Reserve move later this year could also push rates higher once it starts selling Treasury securities or mortgage bonds that the Fed bought during the recession to help ease the housing crisis.

Federal Reserve officials are currently zeroing in on a strategy to begin shrinking their $4.5 trillion portfolio of mortgage and Treasury securities, and a plan, once in place, could possibly begin later this year.

Under the emerging strategy, the Fed would raise short-term interest rates two more times in 2017 and then potentially pause. During a rate-increase hiatus, the Fed could then start winding down their portfolio of securities in a gradual and measured way, assessing how the markets handle the move as it does so. In 2018, if all goes well, the Fed could then resume its policy of slowing raising short-term interest rates, according to interviews and recent public statements from officials.

The strategy depends on whether the economy keeps performing as expected, and it depends on whether Fed Chairwoman Janet Yellen can build a consensus among policy makers about how to proceed. No firm decisions have been made yet.

Fed officials held a discussion on the balance sheet at their March policy meeting. Staff economists have started work on a paper to help forge consensus over the many technical details that have yet to be sorted out, including whether to slow reinvestment in Treasurys and mortgage bonds simultaneously or reduce the holdings of one before the other.