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Data: Federal Reserve; Chart: Axios Visuals

The Federal Reserve has pushed mortgage rates higher not just through its much-discussed interest rate policy decisions, but through two less widely understood channels, a new paper argues.

Why it matters: 

Since 2022, high mortgage rates have made homebuying an expensive endeavor for would-be borrowers and created dysfunction in the housing market.

The big picture: 

But mortgage rates have risen substantially higher than justified by the Fed’s rate hikes alone. That’s thanks in part to a double whammy of two other factors:

1. Quantitative tightening has meant the Fed withdrawing billions from the mortgage market.
2. Higher rates have led banks to do the same as they have lost deposits, says the paper presented by New York University economist Philipp Schnabl on Saturday at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming.

How it works: 

As the Fed looked to stimulate the economy at the onset of the pandemic in 2020 and 2021, it began buying mortgage-backed securities (MBS) on massive scale as part of its quantitative easing program, essentially funneling cash to homebuyers. Its stockpile of MBS rose from $1.4 trillion in March 2020 to $2.7 trillion at the peak.

• Its reversal, part of the Fed’s fight against inflation, has so far drained those holdings by about $400 billion.
• Meanwhile, in 2021, consumers’ rapid accumulation of pandemic savings swelled bank deposits, and banks — needing to deploy those funds — ramped up their own mortgage lending and purchases of MBS. But as rates rose, deposits reversed as depositors had better options in Treasury bills and money market mutual funds.

The intrigue: 

As the Fed tightened policy to fight inflation starting in 2022, it raised its short-term interest rate target, which also led longer-term Treasury bond yields to rise. But the mortgage rates available to consumers rose by even more.

• The spread between the 10-year Treasury yield and average consumer mortgage rate was a mere 1.5% in May 2021, but nearly twice as large, 2.9%, in 2023.
• In other words, homebuyers got hit harder by monetary tightening than the U.S. government. The new paper helps explain why.

What they’re saying: 

“Banks and the Fed bought enormous quantities of mortgages during 2020–21, causing mortgage rates to decline drastically,” write the authors, Itamar Drechsler, Alexi Savov, Schnabl and Dominik Supera.

• “When monetary policy reversed course, banks and the Fed cut back their mortgage holdings, causing mortgage rates to rise and the mortgage spread to widen,” they write. “Monetary policy thus had an outsized impact on mortgage rates.”