Here's a bigger risk for the housing market than what the Fed could do to mortgage rates

Mizuho Securities analysts contend the Federal Reserve is unlikely to intervene to artificially depress mortgage rates, despite recent "euphoria" in government-backed mortgage bonds and calls for Fed action. They argue current rates aren't historically high, the FOMC remains cautious of re-inflating a housing bubble, and affordability is primarily a home price issue. While tightening agency MBS spreads have already lowered rates and spurred refinancing, Mizuho believes direct Fed intervention would not significantly impact home demand, aligning with the central bank's long-term goal of a Treasury-only balance sheet.

Analysis

A divergence exists between recent market optimism and a more cautious analytical outlook regarding the U.S. housing market and potential Federal Reserve intervention. Mizuho Securities analysts argue the Fed is unlikely to artificially depress mortgage rates, viewing the primary obstacle to housing demand as high home prices rather than borrowing costs. They note that current mortgage rates, around 6.26%, are not historically high and that the FOMC remains wary of stoking a new housing bubble. This contrasts with recent "euphoria" in the agency mortgage-backed securities (MBS) market, where spreads over Treasuries have tightened from 160 to 122 basis points since April, fueling a rally and a wave of refinancing. While some market participants suggest the Fed could reinvest MBS proceeds to lower rates, this is considered a "long-shot" that would likely not "move the needle on home demand." This skepticism is reinforced by the Fed's stated long-term goal of a Treasury-only balance sheet, with its MBS holdings already reduced to $2.7 trillion from a peak of nearly $3 trillion. The recent strength is reflected in the year-to-date total returns of the Vanguard Mortgage-Backed Securities ETF (VMBS) at 6.52% and the Janus Henderson Mortgage-Backed Securities ETF (JMBS) at 7.03%.

Key Decisions for Investors

• Investors in mortgage-backed securities should recognize that the recent rally, which has driven strong returns in ETFs like JMBS and VMBS, is largely based on expectations of Fed support that may not materialize.
• Monitor housing price and inventory data as primary indicators for the sector's health, as the analysis suggests these are greater determinants of demand than mortgage rates alone.
• Given the divergence between market euphoria and the high bar for Fed intervention, it may be prudent to consider trimming exposure to agency MBS or hedging against a potential widening of spreads if market hopes for policy support are disappointed.