With Warsh’s Fed overhaul, mortgage rates face a new risk

Federal Reserve Chair Kevin Warsh’s new framework for the U.S. central bank carries significant implications for the mortgage industry and broader housing market — a sector that he admits is already facing a restrictive monetary stance.

While his hawkish tone points to higher-for-longer mortgage rates in the near term, it also signals the potential for lower long-term rates driven by a firm commitment to the Fed’s 2% inflation target. In the interim, however, a stark reduction in forward guidance will likely translate into increased market volatility, according to industry experts.

Wednesday’s policy announcement and press conference offered a clear glimpse of the new era of communication under Warsh. The Federal Open Market Committee (FOMC)’s statement was roughly half its usual length, stripping out forward guidance and the voting roster. Meanwhile, the Summary of Economic Projections (SEP) omitted Warsh’s personal forecast — the first time a sitting Fed chair has declined to share their dot plot.

Warsh said colleagues submitted dots “with pencils” and “big erasers,” signaling low conviction and humility about forecasts. The more that markets are paying attention to what’s happening in the real economy, the more effectively they can price what they believe is most likely to occur, Warsh said. For him, when markets merely reflect Fed guidance, the Fed loses an important source of information.

“It’s a completely radical approach, and markets didn’t like it in the first moment,” said Nash Paradise, director of sales at UMortgage. “Without the crutch of the Fed’s forward guidance, we’re going to have to be more into the data — since the conflict with Iran, the data hasn’t really mattered. That puts us in position for more instability.”

Selma Hepp, chief economist at Cotality, said the forward guidance was fairly broad but provided guardrails around what the Fed was thinking. But she said this strategy could “backfire” and cause more volatility, including for mortgage rates.

“Not knowing what the Fed is thinking generally tends to bring more uncertainty, and that means you may have an uncertainty premium priced in. So it may end up leading to slightly higher mortgage rates.”

Hawkish tone across the board

Overall, economists found the Fed’s tone surprisingly hawkish. Nine policymakers anticipated rate hikes this year, eight projected no change, and only one projected a cut. Inflation projections were also revised higher than anticipated, pushing the Personal Consumption Expenditures (PCE) inflation estimate to 3.6% (up from 2.7% in March).

The market repercussions were immediate. The 2-year Treasury yield jumped roughly 13 basis points and the 10-year yield rose by 5 bps, although the 30-year yield actually dipped by 1 bps.

Despite the hawkish tone, mortgage spreads did not show a meaningful uptick. Jeana Curro, managing director and head of agency MBS research at Bank of America, described yesterday’s FOMC meeting as a “non-event to date.” But Curro added that if rate hikes formally enter the narrative, it could act as a slight negative for mortgages.

Hepp agreed: “Hawkish tone generally means more focus on bringing inflation down — and with inflation being elevated right now and throughout the remainder of this year, that would mean no rate cuts. In the long term, what does that mean? Potentially could have some benefits.”

Paradise, however, pushes back against the popular assumption that a tightening monetary cycle automatically guarantees higher mortgage rates.

“An increase in the Fed funds rate isn’t necessarily a bad thing for mortgage rates. It signals a flip that will help move some of the economic data more favorably, lowering inflation, and the markets could actually react well to that,” Paradise said.

“Mortgage rates have a lot of room to level off. Looking at where they’ve been trading, at where the 10-year yield is, a rate hike is definitely not the end of the world for mortgage rates.”

Currently, the spread between the 10-year yield and the 30-year mortgage rate sits at roughly 220 basis points, leaving plenty of room for tightening, Paradise noted.

Balance-sheet moves

Beyond interest rates, the Fed’s handling of its $1.9 trillion mortgage-backed securities (MBS) portfolio remains a massive variable for housing. Doubts remain over the central bank’s next moves, with the market divided on whether the Fed will actively sell off MBS or simply let the portfolio run off.

According to Curro, Bank of America does not expect the Fed to begin actively selling MBS, believing the market is “still a little bit too fragile” for such a move. The most likely path is continued runoff of the portfolio, with proceeds reinvested into Treasuries, echoing the strategy previously outlined by former Chair Jerome Powell.

“Early on, Warsh was well-characterized as an interest rate dove and a balance-sheet hawk, but we’ve been hesitant to assume that means anything more for mortgages than simply allowing MBS holdings to continue running off while reinvesting into Treasuries,” Curro said.

In a report published Thursday, Wells Fargo analysts said that the real question is how much confidence the market will have in model valuations if the policy regime shifts, forward guidance becomes less reliable and the Fed’s balance-sheet reaction function turns unpredictable.

“To be clear, we still think outright Fed MBS sales that leak volatility back into the market remain a low-probability outcome, but that probability has increased at the margin under the new Chair,” the analysts wrote.

New task forces

Adding another layer of structural change, Warsh also announced a sweeping overhaul of the central bank’s internal operations. This includes the creation of five new task forces to target communications, the balance sheet, data, productivity and jobs, and inflation frameworks.

“Taking a fresh look at all of these areas should ultimately make the Fed operate more efficiently and effectively over time,” said Marty Green, principal at Polunsky Beitel Green. “It will also allow the Fed to perhaps better adjust policy in an economy that may evolve more quickly as artificial intelligence has a greater impact.”  

According to Green, the task forces bring the opportunity to utilize data that may be more available in real time and to eliminate some data points that may be anachronistic but have continued to be used for historical comparison.

And while the Fed has explicitly restated its goal of reining in inflation, the task forces can now closely evaluate exactly how inflation is measured and how its various components respond to monetary policy, he added.